[No. L-9262. July 10, 1959] stipulated, and the sum of P200.
00 as attorney's fees; and with respect to
MARINO S. UMALI, petitioner, vs. EFRAIN Y. MICLAT, respondent.
1. 1.CORPORATION; LlABILITY OF PRESIDENT AND
MANAGER; CONTRACT IN His PERSONAL CAPACITY.—If the
President and General Manager of a corporation contracted for
work to be done in his personal capacity although he described
himself as such,
1110
1110 PHILIPPINE REPORTS ANNOTATED
Umali vs. Miclat
1. signing the contract as "party of the second part" without stating
that he was acting in behalf of the corporation, and there is no
showing that he entered into such contract in behalf of the
corporation or was authorized to do so by its Board of Directors,
he is held personally liable for the said transaction.
1. 2.PENALTY; LIABILITY FOR DAMAGES AND INTEREST IN ADDITION
TO PENALTY.—Under the law, a penalty takes the place of
interests only if there is no stipulation to the contrary, and even
then, damages may still be collected if the obligor refuses to pay
the penalty.
PETITION for review by certiorari of a decision of the Court of Appeals.
The facts are stated in the opinion of the Court.
Zavalla, Bautista & Nuevas for petitioner.
Domingo F. de Guzman for respondent.
BAUTISTA ANGELO, J.:
This is an action to recover certain sums of money, plus damages and
attorney's fees, for some work done by plaintiff for defendant Marino S.
Umali. Defendant Antonio M. Tiongco was included in his capacity as
guarantor of Umali but he was never served with summons. With leave of
Court, defendant Umali filed a third party complaint against Maharlika
Pictures, Inc., a corporation duly organized under the laws of the
Philippines, but because the latter failed to file its answer, it was declared
in default.
Defendant Umali set up the defense that the work done by the plaintiff
was not complete or satisfactory; that the contract upon which the action
is based was executed by the Maharlika Pictures, Inc., of which he is the
President and General Manager, and so plaintiff's action should be directed
against said corporation.
After trial, the lower court rendered judgment ordering defendant Umali
to pay plaintiff the sum of P675.00, plus 10% surcharge thereon as
the second
1111
VOL. 105, JULY 10, 1959 1111
Umali vs. Miclat
claim, to pay the sum of P344.50. The Court ordered that the sums of
P675.00 and P344.50 shall bear 6% interest per annum from the date of
the filing of the complaint until paid. The complaint with respect to
defendant Tiongco and the third party complaint against the corporation
were dismissed. Costs were taxed against defendant Umali.
Umali took the case on appeal to the Court of Appeals, and the decision
of the lower court was affirmed in toto, with costs against appellant. Hence
the present petition for review.
It appears that in accordance with the contract Exhibit "A" and the Job
Order Exhibit "D", appellee prepared posters, a theater show board
display, a theater display standee, a float, and other forms of
advertisement for the showing of the film "LAGRIMAS"; that for the work
specified in Exhibit "A", Umali agreed to pay the sum of P900, of which
appellee was paid P225 in advance; that for the work called for in Exhibit
"D", Umali agreed to pay the sum of P344.50; that the work covered by the
contract and job order above mentioned were completely done and the
articles called for therein delivered to Umali; and that notwithstanding
several demands made upon Umali, he refused to pay without justification.
The first defense set up by appellant is that the contracts which
appellee's action is based were executed by and between the appellee and
the Maharlika Pictures, Inc., of which appellant is the President and General
Manager, and so the action should have been directed against the
corporation and not against him in his personal capacity. Appellant does
not dispute the correctness of the amounts claimed in the complaint.
The Court of Appeals, in meeting this contention, made the following
observation:
"We have gone carefully over the evidence of record, and we have arrived
at the conclusion that the decision appealed from should be affirmed. As
the contract (Exhibit A) would show, Umali signed the same in his personal
capacity. While it is mentioned therein
1112
1112 PHILIPPINE REPORTS ANNOTATED
Umali vs. Miclat
that he is the President and General Manager of Maharlika Pictures, Inc., it
is not stated that, as such, he was duly authorized to enter into the
contract for and on behalf of the corporation. If it were true that it was the
intention of the contracting parties to hold Maharlika Pictures, Inc., solely
and exclusively liable, it was not explained why Umali allowed Maharlika
Pictures, Inc., of which. he was still an Officer at the time of trial of this
case, to be declared in default by not filing its answer to the third-party
complaint filed by him. Neither did Umali present in evidence any
resolution or minutes of meeting of Maharlika Pictures, Inc., which Umali
admits is a corporation duly organized and existing under and by virtue of
the laws of the Philippines, or of its Board of Directors, ratifying the action
of Umali and confirming the contract (Exhibit A) as an act of the
corporation. As President and General Manager of the corporation and the
party appearing to be solely and personally liable under the contract
(Exhibit A), Umali should have taken steps to enable the Board of Directors
of the corporation to adopt a resolution confirming the execution by him of
Exhibit A as an act of the corporation because this was for his own
protection."
We find the above observation supported by the evidence. Indeed it
appears in the contract Exhibit "A" that the one who contracted for the
work to be done is appellant in his personal capacity, although he
described himself therein as President and General Manager of the
Maharlika Pictures, Inc. Umali signed the contract as "party of the second
part" without stating that he was acting in behalf of the corporation. And f
rom what may be gathered f rom the decision both of the lower court and
the Court of Appeals, Umali never explained that when he entered into
such a contract he acted in behalf of the corporation or was authorized to
do so by its Board of Directors. It is strange that, after bringing the
corporation into this case as party-defendant, Umali allowed it to be
declared in def ault being its president and general manager as he claims
to be, which gives rise to the suspicion that his claim is merely an attempt
to shift to the corporation the responsibility for the transaction. The same
consideration may be made with regard to the job order Exhibit "D". It is
true that on its face it appears that the articles mentioned therein were
delivered to the corporation, but apparently
1113
VOL. 105, JULY 10, 1959 1113
Umali vs. Miclat
the requisition of said articles was made by appellant himself for which
reason he was made personally responsible by the trial court and the Court
of Appeals. This is a question of fact which we cannot now look into.
The next question refers to the surcharge of 10% which was agreed
upon in the contract Exhibit "A". It appears therein that if appellant should
fail to pay the balance of P675 after the lapse of 30 days from the date the
exhibition of the film "LAGRIMAS" has started, he should pay a surcharge
of 10% every 30 days thereafter until the amount has been fully paid. It is
claimed that this surcharged is unconscionable and unreasonable, because
it is tantamount to imposing an interest of 10% a month, or 120% a year
on the balance of the obligation until the same is paid in full.
There is merit in this contention. While this surcharge partakes of the
nature of a penal clause which the parties may stipulate under the
law,1 however, one cannot deny that the same is unreasonable, for if that
is to be maintained, we would have that on the basis of P675 which is the
balance that remains outstanding, appellant would pay P67.50 a month, or
P810 a year, which considering the time that has already elapsed since
appellant defaulted, would amount to P3,420. This is indeed a case where
equity demands that the penalty be reduced in fairness to the debtor. And
so, making use of the discretion that the law grants us on the matter, we
are of the opinion that a surcharge of 20% per annum would be
reasonable. We therefore hold that the penalty should be reduced
accordingly.2
The last claim of appellant refers to the portion of the decision which
orders the payment of 6% interest per annum from the date of the filing of
the complaint until full payment of the obligation due, which is also
considered
_______________
1
 Article 1226, new Civil Code.
2
 Article 1229, new Civil Code.
1114
1114 PHILIPPINE REPORTS ANNOTATED
Velayo, etc. vs. Shell Co., P. I. Ltd., etc., et al.
unreasonable considering that appellant was already ordered to pay the
penalty agreed upon.
This claim is untenable in the light of the law and the contract of the
parties. Thus, Article 1226 of the new Civil Code provides that "in
obligations with a penal clause, the penalty shall substitute the indemnity
for damages and the payment of interests in case of non-compliance, if
there is no stipulation to the contrary. Nevertheless, damages shall be paid
if the obligor refuses to pay the penalty.* * *". In other words, the penalty
takes the place of the interests only if there is no stipulation to the
contrary, and even then, damages may still be collected if the obligor
refuses to pay the penalty. In this case not only is there an express
stipulation to pay damages in addition to the penalty, but appellant has
failed to pay his obligation as well as the penalty. This appears in
paragraph (/) of the contract Exhibit "A". The imposition of 6% interest per
annum is, therefore, justified.
Modified with regard to the amount of the surcharge to be imposed on
appellant as above indicated, we hereby affirm the decision appealed from
in all other respects, without pronouncement as to costs.
Parás, C.
J., Bengzon, Padilla, Montemayor, Concepción, Endencia, and Barrera, con
cur.
Decision affirmed with modification.
———————————
 VOL. 167, NOVEMBER 24, 1988 815
Garcia vs. Court of Appeals
Nos. L-82282-83. November 24, 1988.*
ANTONIO M. GARCIA, DYNETICS, INC, and MATRIX MANAGEMENT
CORPORATION, petitioners, vs. COURT OF APPEALS and SECURITY BANK
AND TRUST COMPANY, respondents.
Civil Procedure; Summary Judgment; Court may render summary
judgment when there is no genuine issue as to any material fact and that
the moving party is entitled to a judgment as a matter of law.—A Summary
Judgment may be rendered by a court upon motion of a party before trial
and after submission of pleadings, admissions, documents and/or affidavits
and counter affidavits when it is clear that "except as to the amount of
damages, there is no genuine issue as to any material fact and that the
moving party is entitled to a judgment as a matter of law." (Rule 34, Rules
of Court). By genuine issue is meant an issue of fact which calls for the
presentation of evidence (Cadirao v. Estenzo, 132 SCRA 93) as
distinguished from an issue which is sham, fictitious, contrived, set up in
bad faith, or patently unsubstantial as not to constitute a genuine issue for
trial. (Vergara, Sr. v. Suelto, et al., G.R. No. 74766 December 21, 1987;
Cadiraso v. Estenzo supra; Mercado, et al. v. Court of Appeals, G.R. No. L-
44001 June 10,1988) This can be determined by the court on the basis of
the pleadings, admissions, documents, affidavits and/or counter-affidavits
submitted by the parties to the court.
Same; Same; Same; Obligations of petitioners to respondents are
clearly defined in the pleadings, admissions and the unrebutted affidavit of
Mrs. Marquez.—Undoubtedly, the obligations of the petitioners to the
respondents are clearly defined in the pleadings, admissions and the
unrebutted affidavit of Ms. Marquez who handles the Chemark account.
Same; Same; Same; Same; No material questions of facts tendered
by the defenses as to the main issue.—We find no material questions of
facts tendered by these defenses as to the main issue on whether or not
the petitioners can be held liable to the respondent bank under their
indemnity agreements.
Same; Same; Same; Same; Same; Issue tendered in the first and
second defense is sham and fictitious.—The issue tendered in the first
_______________
*      Sycip, Salazar, Hernandez & Gatmaitan for petitioners.
 THIRD DIVISION.
816
816 SUPREME COURT REPORTS ANNOTATED
Garcia vs. Court of Appeals
defense is "sham and fictitious" in the light of the terms of the
indemnity agreements. Thus, under the indemnity agreements, the
petitioners bound themselves jointly and severally with Chemark in favor
of the respondent bank for the payment, upon demand and without benefit
of excussion, of whatever amount or amounts Chemark may be indebted
to the respondent bank under and by virtue of the credit accommodations.
(Italics supplied) The economic conditions of the country are immaterial to
the issue on the liability of the petitioners under their indemnity
agreements. The issue raised in the second defense, on whether or not the
indemnity agreements were intended as collaterals for future Chemark
loans is likewise sham and fictitious. Under the indemnity agreements, the
petitioners bound themselves to pay whatever amount Chemark may be
indebted to the bank "under and by virtue of aforesaid credit
accommodation(s) including the substitutions, renewals, extensions,
increases, amendments, conversions and revivals of the aforesaid credit
accommodation(s) x x x.
Same; Same; Same; Same; Argument that Dynetics' execution of the
indemnity agreement is contrary to its purposes and therefore ultra vires
and unenforceable does not tender a genuine issue.—The argument as to
whether or not Dynetics' execution of the indemnity agreement is contrary
to its purposes and therefore ultra vires and unenforceable against it does
not tender a genuine issue. The record shows that Dynetics was authorized
to execute the indemnity agreements evidenced by the Corporate
Secretary's certificate (p. 38, 264 Original Records). This was not rebutted.
Same; Interest; No reversible error In the award of interest.—The
increased interest rates are expressly provided for in the amended credit
line agreement and in the two promissory notes executed by Chemark in
favor of Security Bank & Trust Co. We find no reversible error in the award
of interests.
Same; Same; Penalty charges are excessive and unconscionable.—
Penalty interests are in the nature of liquidated damages (Cumagun v.
Philippine American Insurance Co., Inc., et al. G.R. No. 81453 August 15,
1988, Lambert v. Fox, 26 Phil. 588) and may be equitably reduced by the
courts if they are iniquitous or unconscionable. (See Articles 1229, 2227,
New Civil Code). We agree with the petitioner that the penalty charges are
excessive and unconscionable. The interest charges are enough
punishment for the petitioners' failure to comply with their obligations.
817
VOL. 167, NOVEMBER 24, 1988 817
Garcia vs. Court of Appeals
PETITION to review the decision and resolution of the Court of Appeals.
The facts are stated in the opinion of the Court.
     Bengzon, Zarraga, Narciso, Cudala, Pecson & Bengson for private
respondent.
GUTIERREZ, JR., J.:
In a summary judgment rendered by the Regional Trial Court of Makati
in Civil Case No. 10398, the complaint was dismissed for lack of merit and
the petitioners were ordered to pay the private respondent the following:
(a) the unpaid principal sum of P15 million remaining unpaid out of
Chemark's availment of the P20 million credit line, plus 18% interest per
annum and 36% as penalty per annum for Promissory Note No.
DLS/74/540/83 from March 23, 1984 until fully paid; and plus 24% interest
per annum and 36% as penalty per annum for Promissory Note No.
DLS/74/1358/83 from August 9,1983 until fully paid; (b) attorney's fees
equivalent to 10% of the total amount of plaintiffs' obligations and (c) costs
of suit.
The summary judgment was affirmed by the Court of Appeals. The
appellate court's decision and the resolution denying a motion for
reconsideration are now challenged by the petitioners in the instant
petition.
The antecedent facts relevant to the instant petition are as follows:
On April 23,1985 petitioners Dynetics, Inc., Matrix Management and
Trading Corporation and Antonio M. Garcia filed a complaint for declaratory
relief and/or injunction with damages against respondent Security Bank
and Trust Company (SBTC). The plaintiffs sought a judicial declaration that
they were not liable to the defendant bank under certain Indemnity
Agreements they executed in favor of Chemark Electric Motors, Inc. which
had been extended a credit accommodation of about P20,000,000.00 by
the defendant bank. They also prayed for payment of attorney's fees and
costs of suit. Thus, they alleged in their complaint:
818
818 SUPREME COURT REPORTS ANNOTATED
Garcia vs. Court of Appeals
x x x      x x x      x x x
1. "a)There is no valid consideration for the execution of the said
instruments;
2. b)The said instruments had become invalid and ineffective at the
time the defendant finally extended the loan accommodation to
Chemark and that the parties to the said instruments did not
intend the said instruments to cover Chemark's obligations to the
defendant which were subsequently granted under separate and
independent transactions;
3. c)Assuming, without conceding, that there is a valid consideration
for the execution of the aforesaid instruments and that the said
instruments continued to be valid and effective when the
defendant extended a credit accommodation to Chemark, said
instruments are null and void insofar as Dynetics is concerned as
it is ultra vires, being contrary to the purposes of Dynetics, its
powers, licenses and franchise;
4. d)Assuming, without conceding, that the Indemnity Agreement
instruments are valid and enforceable, the obligations of the
plaintiffs thereunder have been extinguished, either by novation
or by the acts and conduct of the defendant, who, under the
circumstances, in refusing the valid and legitimate plea of
Chemark for a reasonable restructuring plan of its obligations has
practically rendered it impossible for Chemark to pay its
obligations to its creditors and to the plaintiffs in the event
plaintiffs are legally obligated to pay Chemark's obligations to the
defendant;
5. e)In the light of present economic conditions, in general, and the
condition of Chemark in particular, as well as the financial
condition of the plaintiffs, the demand of the defendant for the
plaintiffs to pay the Chemark obligations would constitute an
abuse of right as defined in the New Civil Code;
6. f)Considering the present adverse economic conditions plaguing
the entire country, the terms and conditions of the credit
accommodation and the Indemnity Agreement instruments,
assuming that the latter are valid and enforceable, have become
so manifestly difficult as to be beyond the contemplation of the
parties. Under the provisions of Human Relations of the New Civil
Code, as well as the general principles of equity, especially the
doctrine of the 'rebus sic stantibus' and 'the frustration of the
commercial object or frustration of enterprise' and under Article
1267 of the New Civil Code, when the service has become so
difficult as to be manifestly beyond the contemplation of the
parties, the obligor may be released therefrom;
7. g)In addition to the reasons stated in paragraphs e and f hereof,
Chemark, the principal obligor, is not liable for its obligations
under the credit accommodations extended to it by the defendant
819
VOL. 167, NOVEMBER 24, 1988 819
Garcia vs. Court of Appeals
1. because it has been prohibited from complying therewith by a
lawful authority. Under the law on guaranty and surety, the
guarantor or the surety, not being a principal debtor, is not liable
for the obligations unless the principal obligor is likewise liable.
(Article 2054 of the New Civil Code; Hospicio de San Jose v.
Fidelity and Surety Co., 52 Phil. 926; Uy Isabelo v. Yandoc, CA-
G.R. No. 8801-R, June 20, 1956). The debtor in obligations to do
shall also be released when the prestation becomes legally
impossible without the fault of the obligor.(Article 1266 of the
New Civil Code);
2. h)Assuming, without conceding, that the plaintiffs are liable under
the Indemnity Agreement instruments, they are not liable for the
amounts being claimed by the defendant, considering that the
said amounts include the payment of exorbitant interests,
excessive penalties and amounts imputed to be due which are
not, in fact, due." (Rollo, pp. 106-107)
On June 11, 1985 the respondent bank filed its Answer and Counterclaim
with prayer for preliminary attachment. The defendant alleged in its
counterclaim:
ALLEGATIONS COMMON TO ALL DEFENDANTS
 1. "21.Sometime in August, 1981, Chemark was granted by plaintiff a
credit line of P4.0 million consisting of an import LC-TR line of
P2.0 million and an export loan line of P2.0 million.
2. 22.Said credit line was increased in February, 1982 from P4.0
million to P20.0 million, to wit:
     Export loan line—from P2.0 million to P15.0 million
     Import LC-TR—from P2.0 million to P5.0 million
The terms and conditions of this P20.0 million credit are reflected in the
Amended Credit Line Agreement dated February 8, 1982 attached as
Annex "1" hereof;
1. 23.Chemark availed of said credit line and as evidence of said
availments, Chemark executed several promissory notes covering
the following amounts drawn against this credit line, viz;
1. a)The sum of P6,350,750.00 drawn on March 23, 1983 with interest
and penalty at the rate indicated in Promissory Note No.
DLS/74/540/83 to mature on June 21,1983, a copy is attached as
Annex "3";
2. b)The sum of P8,649,250.00 drawn on August 9, 1983 with interest
and penalty at the rate indicated in Promissory Note No.
DLS/74/1358/83 to mature on September 8, 1983, a copy of
which is hereto attached as Annex "4".
820
820 SUPREME COURT REPORTS ANNOTATED
Garcia vs. Court of Appeals
1. 24.Chemark defaulted in paying its obligations under the aforesaid
821
promissory notes when these became due. Despite repeated
demands, Chemark failed and refused to pay its valid and just
obligations to the defendant which, as of December 11,1984,
amounted to P13, 30,596.93 under Promissory Note No,
DLS/74/540/83 and P17,357,117.51 under PN No.
DLS/74/1358/83.
CAUSE OF ACTION AGAINST ANTONIO M. GARCIA
1. 25.Plaintiff Garcia personally bound himself jointly and severally
with Chemark, to pay defendant upon demand and without
benefit of excussion, of whatever amount or amounts Chemark
may be indebted to defendant under and by virtue of the
aforesaid credit line accommodation, including the substitutions,
renewals, extensions, increases and other amendments of the
aforesaid credit accommodations, as well as all other obligations
that Chemark may owe the defendant.
2. 26.Accordingly, plaintiff Garcia executed two (2) lndemnity
Agreements, one dated January 20,1982, a copy of which is
attached hereto and made integral part hereof as Annex "E" and
the other, an Indemnity Agreement dated February 8, 1982, as
Annex "B" of the Complaint;
3. 27.Under the terms of the foregoing Indemnity Agreements
executed by plaintiff Garcia, he further bound himself solidarily
with Chemark in favor of defendant for the faithful compliance of
all the terms and conditions contained in the Amended Credit
Line Agreement (Annex "1").
4. 28.Defendant demanded from plaintiff Garcia the payment of the
outstanding obligation of Chemark in a letter dated October 26,
1984, a copy of which is made Annex "5" to form part hereof.
Defendant reiterated said demand on April 15, 1985.
5. 29.Notwithstanding said demands, plaintiff Garcia failed and
refused, as he still fails and refuses to pay his obligation pursuant
to the indemnity agreements he executed.
CAUSES OF ACTION AGAINST MATRIX MANAGEMENT
& TRADING CORPORATION
1. 30.Plaintiff Matrix bound itself jointly and severally with Chemark in
favor of the defendant for the payment, upon demand and
without benefit of excussion, of whatever amount or amounts
Chemark may be indebted to defendant under and by virtue of
the aforesaid credit line accommodation including the
substitutions, renewals, extensions, increases and other
amendments of the aforesaid credit accommodations, as well as
of the amount of such other obligations that Chemark may owe
the defendant.
VOL. 167, NOVEMBER 24, 1988 821
Garcia vs. Court of Appeals
1. 31.Accordingly, Matrix through its duly authorized officers,
executed an Indemnity Agreement dated February 8,1982, a copy
of which is attached hereto as Annex "A" and incorporated herein
by reference.
2. 32.Under the terms of the foregoing indemnity agreement
executed by Matrix, it further bound itself solidarily with Chemark
in favor of defendant for the faithful compliance of all the terms
and conditions contained in the Credit Line Agreement (Annex
"B").
3. 33.Defendant demanded from Matrix the payment of the
outstanding obligation of Chemark in a letter dated October
26,1984, a copy of which is made Annex "5" to form part hereof.
Defendant reiterated said demand on April 25,1985.
 4. 34.Notwithstanding said demands, Matrix failed and refused, as it
still fails and refuses, to pay its obligation pursuant to the
indemnity agreement it executed in plaintiff's favor.
CAUSE OF ACTION AGAINST DYNETICS, INC.
1. 35.Plaintiff Dynetics bound itself jointly and severally with Chemark
in favor of the defendant for the payment, upon demand and
without benefit of excussion, of whatever amount or amounts
Chemark may be indebted to defendant under and by virtue of
the aforesaid credit line accommodation including the
substitutions, renewals, extensions, increases and other
amendments of the aforesaid credit accommodations, as well as
of the amount of such obligations that Chemark may owe the
defendant.
2. 36.Dynetics executed an indemnity agreement dated February
8,1982, copy of which is attached as annex "A" of the Complaint.
37. Under the terms of the foregoing Indemnity Agreement
executed by Dynetics, it further bound itself solidarily with
Chemark in favor of defendant for the faithful compliance of all
the terms and conditions contained in the Amended Credit Line
Agreement (Annex "1").
3. 38.Defendant demanded from Dynetics the payment of the
outstanding obligation of Chemark in a letter dated October
26,1984, a copy of which is made Annex "5", to form part hereof.
Defendant reiterated said demand on April 25,1985.
4. 39.Notwithstanding said demands, Dynetics failed and refused, as
it still fails and refuses to pay its obligation pursuant to the
indemnity agreement it executed in defendant's favor." (Rollo,
pp. 108-111)
On August 21,1985, the petitioners manifested that "x x x they are
adopting all allegations in their Complaint as their
822
822 SUPREME COURT REPORTS ANNOTATED
Garcia vs. Court of Appeals
answer to the respective counterclaim against each of them." (Original
Records, p. 229)
On September 18,1985, the respondent bank filed a motion for
summary judgment on the ground that the answer to the counterclaim
"tenders no genuine issue as to any material fact, and consists of
mere conclusions of law and fact, and in paragraph 4 thereof, plaintiffs
expressly acknowledged their obligation to defendant and indemnity
agreements dated February 8, 1982 when they admitted "under said
instruments, it was basically provided that for and in consideration of the
credit accommodation in the total amount of Twenty Million
(20,000,000.00) Pesos, granted by defendant in favor of Chemark Electric
Motors, Inc., a corporation duly organized and existing under the laws of
the Philippines, plaintiffs agreed to indemnify defendant in the event
Chemark should fail to comply with its obligations.'" (Original Records, p.
248) In support of the motion, the respondent bank attached the affidavit
dated September 17,1985 of Ms. Charis Marquez, Senior Assistant
Manager, corporate banking group, SBTC including its annexes.
The petitioners filed an opposition to the motion for summary judgment
but to no avail. The lower court rendered a decision granting the motion for
summary judgment. The petitioners' complaint was dismissed and they
were ordered to pay the respondent bank under the indemnity
agreements.
The petitioners then filed with the Court of Appeals: 1) an appeal from
the summary judgment and 2) a special civil action for certiorari and
prohibition with a prayer for preliminary injunction to annul the orders of
the Iower court granting motion for summary judgment and granting
motion for execution pending appeal. The two cases were consolidated.
The appellate court sustained the summary judgment. Both petitions
were dismissed with costs against the petitioners. A motion for
reconsideration thereto was denied.
Hence, this petition.
On March 30,1988, we issued a temporary restraining order to enjoin
the enforcement of the questioned decision of the appellate court. In a
Resolution dated June 6, 1988, we gave due course to the petition.
The issue raised in the petition is whether or not the appel-
823
VOL. 167, NOVEMBER 24, 1988 823
Garcia vs. Court of Appeals
late court committed reversible error when it sustained the trial court's
summary judgment.
The petitioners submit that the appellate court committed such an
error, to wit:
1. "a.The rendition of Judge Mendoza's Summary Judgment was
improper because petitioners' Complaint and SBTC's Answer with
Counterclaim raise triable issues of fact. The Court of Appeals,
therefore, erred when it sustained Judge Mendoza's Summary
Judgment.
2. b.Assuming (the untrue) that there were no 'genuine issues as to
any material fact,' the awards set out in Judge Mendoza's
Summary Judgment were rendered in violation of rules of
evidence and laws and jurisprudence on interest, penalties and
attorney's fees. The appellate court, therefore, committed the
same violation when it upheld Judge Mendoza's Summary
Judgment." (Rollo, p. 325).
A Summary Judgment may be rendered by a court upon motion of a party
before trial and after submission of pleadings, admissions, documents
and/or affidavits and counter affidavits when it is clear that "except as to
the amount of damages, there is no genuine issue as to any material fact
and that the moving party is entitled to a judgment as a matter of law."
(Rule 34, Rules of Court). By genuine issue is meant an issue of fact which
calls for the presentation of evidence (Cadirao v. Estenzo, 132 SCRA 93) as
distinguished from an issue which is sham, fictitious, contrived, set up in
bad faith, or patently unsubstantial as not to constitute a genuine issue for
trial. (Vergara, Sr. v. Suelto, et al., G.R. No. 74766 December
21,1987, Cadirao v. Estenzo supra; Mercado, et al. v. Court of Appeals, G.R.
No. L-44001 June 10,1988) This can be determined by the court on the
basis of the pleadings, admissions, documents, affidavits and/or counter-
affidavits submitted by the parties to the court. (Section 3, Rule 34,
Revised Rules of Court; Vergara v. Suelto supra; Cadirao v. Estenzo supra).
The pleadings, admissions and affidavits submitted in court in this case
reveal the following facts:
In August 1981, Chemark was granted by respondent bank a credit line
of P4.0 million which was increased in February 1982 to P20.0 million, to
wit; Export loan line—from P2.0 million to P15.00 million; Import LC/TR—
from P2.0 million to
824
824 SUPREME COURT REPORTS ANNOTATED
Garcia vs. Court of Appeals
P5.0 million. The terms and conditions of this P20 million credit are stated
in the Credit Line Agreement dated February 8,1982 (p. 254, Records). On
this same day, February 8,1982 the petitioners executed separate, but
with similar terms, indemnity agreements whereby they bound themselves
jointly and severally with Chemark to pay respondent bank upon demand
and without excussion of whatever amount Chemark may be indebted to
said bank by virtue of said credit line accommodation including the
substitution, renewals, extensions, increases and other amendments
thereof; and that upon default of Chemark, proper demands to pay were
made on the petitioners to comply with their obligations. The three
indemnity agreements binding each of the petitioners contain the following
provisions:
INDEMNITY AGREEMENT
KNOW ALL MEN BY THESE PRESENTS: That—
"DYNETICS, INC., a corporation duly organized and existing under and by
virtue of the laws of the Philippines, with offices at the FTI Complex,
Taguig, Metro Manila—for and in consideration of the credit
accommodation in the total amount of TWENTY MILLION (P20,000,000.00)
PESOS granted by the SECURITY BANK & TRUST COMPANY, a commercial
banking corporation duly organized and existing under and by virtue of the
laws of the Philippines, with offices at 6778 Ayala Avenue, Makati, Metro
Manila, hereinafter referred to as the BANK, in favor of CHEMARK ELECTRIC
MOTORS, INC., xxx a corporation duly organized and existing under and by
virtue of the laws of the Philippines, with offices at the 2nd Floor, Princess
Building, Esteban Street, Legaspi Village, Makati, Metro Manila, hereinafter
referred to as the CLIENT, with the stipulated interests and charges
thereon, evidenced by that/those certain AMENDED CREDIT LINE
AGREEMENT made 'and executed by and between the CLIENT and the
BANK on even date—hereby bind(s) himself/themselves jointly and
severally with the CLIENT in favor of the BANK for the payment, upon
demand and without benefit of excussion, of whatever amount or amounts
the CLIENT may be indebted to the BANK under and by virtue of aforesaid
credit accommodation(s) including the substitutions, renewals, extensions,
increases, amendments, conversions and revivals of the aforesaid credit
accommodation(s), as well as of the amount or amounts of such other
obligations that the CLIENT may owe the BANK, whether
825
VOL. 167, NOVEMBER 24, 1988 825
Garcia vs. Court of Appeals
books and records of the BANK, plus interest and expenses arising from
any agreement or agreements that may have heretofore been made, or
may hereafter be executed by and between the parties thereto, including
the substitutions, renewals, extensions, increases, amendments,
conversions and revivals of the aforesaid credit accommodation(s), and
further bind(s) himself/themselves with the CLIENT in favor of the BANK for
the faithful compliance of all the aforesaid credit accommodation(s), all of
which are incorporated herein and made part hereof by reference.
IN WITNESS WHEREOF, these presents are signed at Makati, Metro
Manila on this 8th day of February, 1982. xxx and/or its trust accounts
funding this loan—
     DYNETICS, INC.
(SGD.) ANTONIO M. GARCIA
(SGD.) DOMINADOR GAMEZ
Signed in the Presence of:
(SGD.) JONA C. CAJUYONG
(SGD.) TERESITA A. DE GUZMAN"
(Original Records, pp. 306-307)
Both Dynetics and Matrix were authorized by their respective board of
directors to execute the indemnity agreements. In the case of Dynetics,
Corporate Secretary Antonio Pastelero certified that during a meeting of
the Board of Directors held on December 29,1981 at its office address, it
was unanimously adopted that the corporation "x x x undertake to jointly
and severally guarantee the credit line of CHEMARK ELECTRIC MOTORS,
INC. in favor of the SECURITY BANK & TRUST COMPANY, in an amount not
to exceed TWENTY MILLION (20,000,000.00) PESOS" (p. 264, Original
Records). In the case of MATRIX, Corporate Secretary Rene J. Katigbak
certified that at the meeting of the Board of Directors held on December
28, 1981, a resolution was unanimously adopted to have the corporation "x
x x jointly and severally guarantee the credit line of CHEMARK ELECTRIC
MOTORS, INC. in favor of the SECURITY BANK & TRUST COMPANY, in an
amount not to exceed TWENTY MILLION (P20,000,000.00) PESOS."
(Original Records, p. 262) 825
826
826 SUPREME COURT REPORTS ANNOTATED

Garcia vs. Court of Appeals
Chemark then availed of the P20.0 million credit line and executed two (2)
promissory notes covering the following amounts drawn against the Export
Loan Line, to wit:
1. "a)The sum of P6,350,750.00 drawn on March 23, 1983 with
interest and penalty at the rate indicated in Promissory Note No.
DLS/74/540/83 to mature on June 21, 1983" (p. 255, Original
Records)
2. "b)The sum of P8,649,250.00 drawn on August 9, 1983 with
interest and penalty at the rate indicated in Promissory Note No.
DLS/74/1358/83 to mature on September 8, 1983" (p. 256,
Original Records)
These obligations were not paid by Chemark when they became due.
Hence, the respondent bank demanded from the petitioners under the
indemnity agreements the payment of the outstanding obligations of
Chemark.
Undoubtedly, the obligations of the petitioners to the respondents are
clearly defined in the pleadings, admissions and the unrebutted affidavit of
Ms. Marquez who handles the Chemark account.
Nevertheless, the petitioners insist that their complaint for declaratory
relief tenders genuine issues which should be threshed out in a full-blown
trial, to wit:
xxx      xxx      xxx
1. "11.1First Defense: that the principal obligation has not yet
matured because SBTC, agreed to allow Chemark a grace period
within which to recover its liquidity and pay the debt.
2. 11.1AThis defense is pleaded in the following allegations of the
Complaint:
1. "'6.In the aftermath of the assassination of Senator Benigno S.
Aquino, Jr., on August 21, 1983, the Philippine economy was
plunged into a deep crisis. There was a massive flight of capital;
the country's balance of payments deteriorated; business and
industry practically stood still; and the foreign debts of the
country could not be serviced; banks collapsed, the exchange
rate between the Philippine Peso and US Dollar tripled and there
was practically no foreign exchange available in the country. The
resultant extremely adverse economic conditions were not
foreseen or contemplated by persons or entities who became
parties to a contract. None of the parties
827
VOL. 167, NOVEMBER 24, 1988 827
Garcia vs. Court of Appeals
828
1. to a contract expected nor did they intend that the terms and
conditions they agreed upon would operate under extreme
adverse economic conditions.
2. '7.Because of the recent economic developments here and abroad,
the failure of one of the stockholders of Chemark to comply with
its commitments and Chemark's inability to collect substantial
receivables from its marketing representatives in the United
States, Chemark started to suffer liquidity problems. As a
consequence, it was unable to pay its creditors, among whom is
the defendant. However, Chemark had more than sufficient
assets to pay all its obligations including its obligations to the
defendant, except that its liquidity problems prevented it from
paying its creditors.
3. '8.Chemark started negotiating with the defendant for the
restructuring of its obligations to the latter. For this purpose, it
submitted several proposed courses of action to the defendant
whereby in time all of its obligations to the defendant would be
paid.
4. '9.In the meantime, the defendant demanded payment from the
plaintiffs of the obligations of Chemark. Although plaintiffs are not
legally liable for the payment of such obligations, they
nonetheless, proposed to the defendant that the latter allow
Chemark to recover its liquidity until such time that it shall have
recovered its ability to pay its obligations. An agreement in
principle was reached on this proposal and the defendant
committed itself to allow Chemark to recover from its liquidity
problems and to refrain from demanding payment of the loans of
Chemark from the plaintiffs. (Italics supplied)." (Rollo, pp. 328-
329).
xxx      xxx      xxx
1. "11.2Second Defense: that SBTC and the petitioners did not intend
to use petitioners' Indemnity Agreements as collateral security
for Chemark's loans and that SBTC extended the loan solely on
Chemark's viability as a business enterprise.
2. "11.2AThe Complaint pleads this defense in the following
paragraphs:
1. '5.xxx when the defendant finally extended the loan to Chemark, it
did so not because of the aforesaid instruments (referring to the
Indemnity Agreements) previously executed by the (petitioners)
which, in the meantime, were no longer valid and effective
and intended by the parties as collateral security for future
Chemark loans, but because of defendant's assessment of the
viability of Chemark's business operations
828
SUPREME COURT REPORTS ANNOTATED

Garcia vs. Court of Appeals
1. and interest income expected to be generated from the loans to
Chemark.' (Italics supplied) (Rollo, pp. 329-330)
xxx      xxx      xxx
1. "11.3Third Defense: that Dynetic's execution of the Indemnity
Agreement is contrary to its purposes and is therefore ultra vires
and unenforceable against it.
2. 11.3AThis defense is pleaded in the Complaint as follows:
'13.Plaintiffs are not liable to the defendant under the Indemnity
Agreement instruments xxx for the following reasons:
xxx      xxx      xxx
1. (c)Assuming, without, conceding, that there is a valid consideration
for the execution of the aforesaid instruments and that said
instruments continued to be valid and effective when the
defendant extended a credit accommodation to Chemark, said
instruments are null and void insofar as Dynetics is concerned as
it is ultra vires, being contrary to the purpose of Dynetics, its
powers, licenses and franchise: (Italics supplied)'" (Rollo, pp. 332-
333)
We find no material questions of facts tendered by these defenses as to
the main issue on whether or not the petitioners can be held liable to the
respondent bank under their indemnity agreements.
The issue tendered in the first defense is "sham and fictitious" in the
light of the terms of the indemnity agreements. Thus, under the indemnity
agreements, the petitioners bound themselves jointly and severally with
Chemark in favor of the respondent bank for the payment, upon demand
and without benefit of excussion, of whatever amount or amounts
Chemark may be indebted to the respondent bank under and by virtue of
the credit accommodations. (Italics supplied) The economic conditions of
the country are immaterial to the issue on the liability of the petitioners
under their indemnity agreements.
The issue raised in the second defense, on whether or not the
indemnity agreements were intended as collaterals for future Chemark
loans is likewise sham and fictitious. Under the indemnity agreements, the
petitioners bound themselves to pay whatever amount Chemark may be
indebted to the bank "under and by virtue of aforesaid credit
accommodation(s)
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VOL. 167, NOVEMBER 24, 1988 829
Garcia vs. Court of Appeals
including the substitutions, renewals, extensions, increases, amendments,
conversions and revivals of the aforesaid credit accommodation(s) x x x."
(Italics supplied)
The argument as to whether or not Dynetics' execution of the
indemnity agreement is contrary to its purposes and therefore ultra vires
and unenforceable against it does not tender a genuine issue. The record
shows that Dynetics was authorized to execute the indemnity agreements
evidenced by the Corporate Secretary's certificate (p. 38, 264 Original
Records).
This was not rebutted.
Indeed, we find no genuine issues raised in the complaint which can not
be resolved by the pleadings, admissions and the affidavit of Charis
Marquez submitted to the court. As the appellate court said:
"Dynetics, Garcia and Matrix attempted to avoid liability by trying hard to
create factual issues fit for trial. The attempt is but a hodgepodge of legal
arguments and conclusions which can be resolved without the rituals of
trial. Thus, Dynetics urges that there is need for trial to determine whether
it can be compelled to pay considering that SEC by its Order of September
27,1984 has prohibited Chemark from paying its creditors. The issue is
strictly legal and can be decided by determining the character of liability of
Dynetics as joint and solidary debtor. Dynetics also argues that it raised
the issue of lack of consideration which must be tried on the merits. The
issue deserves scant consideration for the parties' Indemnity Agreement
specifies the consideration to be the grant of credit accommodation to
Chemark in the sum of P20 M. Also what is posed is a legal issue resolvable
in light of the character of Dynetics as a joint and solidary debtor. Dynetics
also asseverates that it did not intend its Indemnity Agreement as
collaterals for future Chemark loans. This is a clear pretense considering
that again under its Indemnity Agreement, Dynetics clearly bound itself to
pay whatever amount Chemark may be indebted to Security Bank 'under
and by virtue of the aforesaid credit accommodation(s) including the
substitutions, renewals, extensions, increases, amendments, conversions
and revivals of aforesaid credit accommodation(s.)' There is nothing on
record to substantiate the pretense of mistake of Dynetics." (Rollo, p. 121)
xxx      xxx      xxx
'Then Dynetics argues that it has raised the issue of novation in light of
the new loan contracts between Security Bank and Chemark. Again, the
alleged new contracts are established facts and need not
830
830 SUPREME COURT REPORTS ANNOTATED
Garcia vs. Court of Appeals
be the subject of trial. Upon their basis, the court can conclude whether
there is novation of contract." (Rollo, p. 125)
The petitioners also assail the awards of penalty charges at 36% per
annum and interest at 18% and 24% per annum respectively on the loans.
They contend that the interests are excessive and are not sustained by the
evidence because the rate of interest stipulated in the promissory notes is
only 11% per annum.
 The lower courts based the computation of interests and penalty
charges on the affidavit of Charis Marquez, Assistant Manager of the
Corporate Banking Group of Security Bank & Trust Co. Marquez was the
account officer who handled the account of Chemark. The pertinent
portions of the affidavit read as follows:
1. "22.As per statements of Accounts dated June 15, 1985, under the
said promissory notes (Annexes '2' and '3' hereof) covered by the
subject Indemnity Agreements (Annexes '4' '7' and '8' hereof), the
total outstanding obligation of Dynetics, Inc., Matrix Management
& Trading Corporation and Antonio M. Garcia to Security Bank &
Trust Co. was P38,1 89,038.27, including interest and charges.
Attached hereto as Annexes '9' and 10' are copies of said
Statements of Accounts dated June 15, 1985;
2. 23.In the said Statements of Accounts dated June 15,1985, we
charged 18% and 25% per annum, respectively, because the
subject loans (Annexes '2' and '3' hereof) were intended to be
rediscounted at the Central Bank at 11% per annum. However,
when Chemark Electric Motors, Inc. failed to give us the required
letter of credit which was a requirement of the Central Bank, we
charged them 18% and 24% instead of 11% interest per annum.
These higher interest charges were based on and authorized
under our Credit Proposal, copies of which are hereto attached as
Annexes 11' to '11-B'." (Original Records, p. 252)
The increased interest rates are expressly provided for in the amended
credit line agreement and in the two promissory notes executed by
Chemark in favor of Security Bank & Trust Co. We find no reversible error
in the award of interests.
The penalty of 36% per annum is provided in the promissory notes
(Annexes "3", "4" Affidavit), as follows:
831
VOL. 167, NOVEMBER 24, 1988 831
Garcia vs. Court of Appeals
"If this note is not fully paid when due, the undersigned shall pay, in
addition to the stipulated interest, a penalty of 3% per month on the total
outstanding principal and interest due and unpaid. x x x" (Original Records,
p. 256)
The affidavit and supporting documents were attached to the respondent
bank's motion for summary judgment. The petitioners failed to oppose
Marquez' affidavit in their "Oppositions" to the motion for summary
judgment. Neither did they submit counter-affidavits, as was their right, to
oppose these amounts due from them including the increased interests
and penalty charges. Under these circumstances, the respondent bank was
entitled to summary judgment (Philippine National Bank v. Phil. Leather
Co., Inc., et al. 105 Phil. 400; See also Mercado, et al. v. Court of
Appeals supra). As earlier stated, the lower court committed no reversible
error in awarding the questioned interests. We cannot, however, agree
with the appellate court as regards the award of penalty charges at 36%
per annum.
Penalty interests are in the nature of liquidated damages (Cumagun v.
Philippine American Insurance Co., Inc., et al. G.R. No. 81453 August 15,
1988; Lambert v. Fox, 26 Phil. 588) and may be equitably reduced by the
courts if they are iniquitous or unconscionable. (See Articles 1229, 2227,
New Civil Code).
The records show that on the first loan, the principal of which
is P6,350,750.00, the penalty charges as of June 15, 1985 are already
equivalent to P6,774.378.06 (p. 265, Original Records) and that on the
second loan, the principal of which is P8,649,250.00 the penalty charges
as of June 15, 1985 are equivalent to P8,662,008.53. (p. 266, Original
Records) The P6,774,378.06 penalty charges in the first loan would have
been earned by the private respondent after only 725 days (1 year and
360 days) of delay in the payment of the loan while the P8,662,008.53
penalty charges would have been earned by the private respondent after
only 646 days (1 year and 281 days) of delay in the payment of the loan.
The figures from 1985 to 1988 would amount to several times the principal
loans.
We agree with the petitioner that the penalty charges are excessive
and unconscionable. The interest charges are enough
832
832 SUPREME COURT REPORTS ANNOTATED
Garcia vs. Court of Appeals
punishment for the petitioners' failure to comply with their obligations.
Finally, the petitioners question the amount for attorney's fees
equivalent to 10% of their obligation.
Again, Chemark's promissory notes provide for the award of attorney's
fees in case of default to pay the loans, to wit:
xxx      xxx      xxx
"If this note is not fully paid when due, the undersigned shall pay, in
addition to the stipulated interest, a penalty of 3% per month on the total
outstanding principal and interest due and unpaid. The undersigned shall
also pay, as and for attorney's fee, a sum equivalent to 20% of the total
amount due under this note plus expenses and costs of collection, in case
this note is placed in the hands of an attorney for collection." (See Annexes
'2', '3', Affidavit of Charis Marquez) (Original Records, p. 255)
The award for attorney's fees is justified and, in fact, is even lower than
that agreed upon by the parties.
WHEREFORE, the instant petition is DISMISSED. The questioned
decision and resolution of the Court of Appeals are AFFIRMED except for
the award of penalty charges which is stricken from the judgment. The
Temporary Restraining Order issued on March 30, 1988 is LIFTED. Costs
against the petitioners.
SO ORDERED.
     Fernan, (C.J.), Bidin and Cortés, JJ., concur.
     Feliciano, J., No part. Petitioners are represented by my former
firm.
 Petition dismissed. Decision and resolution affirmed.
Notes.—Relief of summary judgment is intended to expedite or
promptly dispose of cases where the facts appear undisputed and certain
from the pleadings, dispositions, admissions and affidavits. (Viajar vs.
Estenzo, 89 SCRA 684).
There is no basis for issuance of Summary Judgment for failure to
observe guidelines, (Viajar vs. Estenzo, 89 SCRA 684).

——o0o——

83
292 SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Court of Appeals
G.R. Nos. 128833, 128834, and 128866. April 20, 1998.*
RIZAL COMMERCIAL BANKING CORPORATION, UY CHUN BING AND ELI D.
LAO, petitioners, vs. COURT OF APPEALS and GOYU & SONS, INC.,
respondents.
RIZAL COMMERCIAL BANKING CORPORATION, petitioner, vs. COURT OF
APPEALS, ALFREDO C. SEBASTIAN, GOYU & SONS, INC., GO SONG HIAP,
SPOUSES GO TENG KOK and BETTY CHIU SUK YING alias BETTY GO,
respondents.
MALAYAN INSURANCE, INC., petitioner, vs. GOYU & SONS, INC., respondent.
Civil Law; Insurance Law; Mortgages; It is settled that a mort-gagor
and a mortgagee have separate and distinct insurable interests in the
same mortgaged property, such that each one of them may insure the
same property for his own sole benefit; The intentions of the parties as
shown by their contemporaneous acts, must be given due consideration in
order to better serve the interest of justice and eq-
_______________
*
 SECOND DIVISION.
293
VOL. 289, APRIL 20, 1998 293
Rizal Commercial Banking Corporation vs. Court of Appeals
uity.—It is settled that a mortgagor and a mortgagee have separate
and distinct insurable interests in the same mortgaged property, such that
each one of them may insure the same property for his own sole benefit.
There is no question that GOYU could insure the mortgaged property for its
own exclusive benefit. In the present case, although it appears that GOYU
obtained the subject insurance policies naming itself as the sole payee, the
intentions of the parties as shown by their contemporaneous acts, must be
given due consideration in order to better serve the interest of justice and
equity.
Same; Same; Same; It is basic and fundamental that the first
mortgagee has superior rights over junior mortgagees or attaching
creditors.—Anent the right of RCBC to intervene in Civil Case No. 1073,
before the Zamboanga Regional Trial Court, since it has been determined
that RCBC has the right to the insurance proceeds, the subject matter of
intervention is rendered moot and academic. Respondent Sebastian must,
however, yield to the preferential right of RCBC over the MICO insurance
policies. It is basic and fundamental that the first mortgagee has superior
rights over junior mortgagees or attaching creditors.
Same; Same; Section 53 of the Insurance Code ordains that the
insurance proceeds of the endorsed policies shall be applied exclusively to
the proper interest of the person for whose benefit it was made.—The
proceeds of the 8 insurance policies endorsed to RCBC aggregate to
P89,974,488.36. Being exclusively payable to RCBC by reason of the
endorsement by Alchester to RCBC, which we already ruled to have the
force and effect of an endorsement by GOYU itself, these 8 policies can not
be attached by GOYU’s other creditors up to the extent of the GOYU’s
outstanding obligation in RCBC’s favor. Section 53 of the Insurance Code
ordains that the insurance proceeds of the endorsed policies shall be
applied exclusively to the proper interest of the person for whose benefit it
was made. In this case, to the extent of GOYU’s obligation with RCBC, the
interest of GOYU in the subject policies had been transferred to RCBC
effective as of the time of the endorsement.
Same; Same; For an insurance company to be held liable for
unreasonably delaying and withholding payment of insurance proceeds,
the delay must be wanton, oppressive, or malevolent.—For an insurance
company to be held liable for unreasonably delaying and withholding
payment of insurance proceeds, the delay must be wan-
294
294 SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Court of Appeals
ton, oppressive, or malevolent (Zenith Insurance Corporation vs. CA,
185 SCRA 403 [1990]). It is generally agreed, however, that an insurer may
in good faith and honesty entertain a difference of opinion as to its liability.
Accordingly, the statutory penalty for vexatious refusal of an insurer to pay
a claim should not be inflicted unless the evidence and circumstances
show that such refusal was willful and without reasonable cause as the
facts appear to a reasonable and prudent man (Buffalo Ins. Co. vs.
Bommarito [CCA 8th] 42 F [2d] 53, 70 ALR 1211; Phoenix Ins. Co. vs. Clay,
101 Ga. 331, 28 SE 853, 65 Am St Rep 307; Kusnetsky vs. Security Ins. Co.,
313 Mo. 143, 281 SW 47, 45 ALR 189). The case at bar does not show that
MICO wantonly and in bad faith delayed the release of the proceeds.
Same; Same; Interests; The essence or rationale for the payment of
interest or cost of money is separate and distinct from that of surcharges
and penalties; Court fails to find justification for the Court of Appeals’
outright deletion of the payment of interest as agreed upon in the
respective promissory notes.—The essence or rationale for the payment of
interest or cost of money is separate and distinct from that of surcharges
and penalties. What may justify a court in not allowing the creditor to
charge surcharges and penalties despite express stipulation therefor in a
valid agreement, may not equally justify non-payment of interest. The
charging of interest for loans forms a very essential and fundamental
element of the banking business, which may truly be considered to be at
the very core of its existence or being. It is inconceivable for a bank to
grant loans for which it will not charge any interest at all. We fail to find
justification for the Court of Appeals’ outright deletion of the payment of
interest as agreed upon in the respective promissory notes. This
constitutes gross error.
PETITIONS for review on certiorari of a decision of the Court of Appeals.
The facts are stated in the opinion of the Court.
     Siguion Reyna, Montecillo & Ongsiako for petitioner RCBC.
     Rodolfo P. del Prado for private respondent Goyu & Sons, Inc.
     Manuel Melotindos for private respondent Go Song Hiap, Spouses Go
Teng Kok and Betty Chiu alias Betty Go, Jr.
295
VOL. 289, APRIL 20, 1998 295
Rizal Commercial Banking Corporation vs. Court of Appeals
     Linda Eustaquio-Lim for private respondent Alfredo C. Sebastian.
MELO, J.:
The issues relevant to the herein three consolidated petitions revolve
around the fire loss claims of respondent Goyu & Sons, Inc. (GOYU) with
petitioner Malayan Insurance Company, Inc. (MICO) in connection with the
mortgage contracts entered into by and between Rizal Commercial
Banking Corporation (RCBC) and GOYU.
The Court of Appeals ordered MICO to pay GOYU its claims in the total
amount of P74,040,518.58, plus 37% interest per annum commencing July
27, 1992. RCBC was ordered to pay actual and compensatory damages in
the amount of P5,000,000.00. MICO and RCBC were held solidarily liable to
pay GOYU P1,500,000.00 as exemplary damages and P1,500,000.00 for
attorney’s fees. GOYU’s obligation to RCBC was fixed at P68,785,069.04 as
of April 1992, without any interest, surcharges, and penalties. RCBC and
MICO appealed separately but, in view of the common facts and issues
involved, their individual petitions were consolidated.
The undisputed facts may be summarized as follows:
GOYU applied for credit facilities and accommodations with RCBC at its
Binondo Branch. After due evaluation, RCBC Binondo Branch, through its
key officers, petitioners Uy Chun Bing and Eli D. Lao, recommended
GOYU’s application for approval by RCBC’s executive committee. A credit
facility in the amount of P30 million was initially granted. Upon GOYU’s
application and Uy’s and Lao’s recommendation, RCBC’s executive
committee increased GOYU’s credit facility to P50 million, then to P90
million, and finally to P117 million.
As security for its credit facilities with RCBC, GOYU executed two real
estate mortgages and two chattel mortgages in favor of RCBC, which were
registered with the Registry of Deeds at Valenzuela, Metro Manila. Under
each of these four mortgage contracts, GOYU committed itself to insure
the
296
296 SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Court of Appeals
mortgaged property with an insurance company approved by RCBC, and
subsequently, to endorse and deliver the insurance policies to RCBC.
GOYU obtained in its name a total of ten insurance policies from MICO.
In February 1992, Alchester Insurance Agency, Inc., the insurance agent
where GOYU obtained the Malayan insurance policies, issued nine
endorsements in favor of RCBC seemingly upon instructions of GOYU
(Exhibits “1-Malayan” to “9-Malayan”).
On April 27, 1992, one of GOYU’s factory buildings in Valenzuela was
gutted by fire. Consequently, GOYU submitted its claim for indemnity on
account of the loss insured against. MICO denied the claim on the ground
that the insurance policies were either attached pursuant to writs of
attachments/garnishments issued by various courts or that the insurance
proceeds were also claimed by other creditors of GOYU alleging better
rights to the proceeds than the insured. GOYU filed a complaint for specific
performance and damages which was docketed at the Regional Trial Court
of the National Capital Judicial Region (Manila, Branch 3) as Civil Case No.
93-65442, now subject of the present G.R. Nos. 128833 and 128866.
RCBC, one of GOYU’s creditors, also filed with MICO its formal claim
over the proceeds of the insurance policies, but said claims were also
denied for the same reasons that MICO denied GOYU’s claims.
In an interlocutory order dated October 12, 1993 (Record, pp. 311-312),
the Regional Trial Court of Manila (Branch 3), confirmed that GOYU’s other
creditors, namely, Urban Bank, Alfredo Sebastian, and Philippine Trust
Company obtained their respective writs of attachments from various
courts, covering an aggregate amount of P14,938,080.23, and ordered that
the proceeds of the ten insurance policies be deposited with the said court
minus the aforementioned P14,938,080.23. Accordingly, on January 7,
1994, MICO deposited the amount of P50,505,594.60 with Branch 3 of the
Manila RTC.
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VOL. 289, APRIL 20, 1998 297
Rizal Commercial Banking Corporation vs. Court of Appeals
In the meantime, another notice of garnishment was handed down by
another Manila RTC sala (Branch 28) for the amount of P8,696,838.75
(Exhibit “22-Malayan”).
After trial, Branch 3 of the Manila RTC rendered judgment in favor of
GOYU, disposing:
WHEREFORE, judgment is hereby rendered in favor of the plaintiff and
against the defendant, Malayan Insurance Company, Inc. and Rizal
Commercial Banking Corporation, ordering the latter as follows:
1. 1.For defendant Malayan Insurance Co., Inc.:
1. a.To pay the plaintiff its fire loss claims in the total amount of
P74,040,518.58 less the amount of P50,000,000.00 which is
deposited with this Court;
2. b.To pay the plaintiff damages by way of interest for the duration
of the delay since July 27, 1992 (ninety days after defendant
insurer’s receipt of the required proof of loss and notice of loss) at
the rate of twice the ceiling prescribed by the Monetary Board, on
the following amounts:
 1. 1)P50,000,000.00—from July 27, 1992 up to the time said amount
was deposited with this Court on January 7, 1994;
2. 2)P24,040,518.58—from July 27, 1992 up to the time when the
writs of attachments were received by defendant Malayan;
1. 2.For defendant Rizal Commercial Banking Corporation:
1. a.To pay the plaintiff actual and compensatory damages in the
amount of P2,000,000.00;
1. 3.For both defendants Malayan and RCBC:
1. a.To pay the plaintiff, jointly and severally, the following amounts:
1. 1)P1,000,000.00 as exemplary damages;
2. 2)P1,000,000.00 as, and for, attorney’s fees;
3. 3)Costs of suit.
and on the Counterclaim of defendant RCBC, ordering the plaintiff to pay
its loan obligations with defendant RCBC in the amount of P68,785,069.04,
as of April 27, 1992, with inter
298
298 SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Court of Appeals
est thereon at the rate stipulated in the respective promissory notes
(without surcharges and penalties) per computation, pp. 14-A, 14-B & 14-C.
FURTHER, the Clerk of Court of the Regional Trial Court of Manila is
hereby ordered to release immediately to the plaintiff the amount of
P50,000,000.00 deposited with the Court by defendant Malayan, together
with all the interests earned thereon.
(Record, pp. 478-479.)
From this judgment, all parties interposed their respective appeals. GOYU
was unsatisfied with the amounts awarded in its favor. MICO and RCBC
disputed the trial court’s findings of liability on their part. The Court of
Appeals partly granted GOYU’s appeal, but sustained the findings of the
trial court with respect to MICO and RCBC’s liabilities, thusly:
WHEREFORE, the decision of the lower court dated June 29, 1994 is hereby
modified as follows:
1. 1.FOR DEFENDANT MALAYAN INSURANCE CO., INC.:
1. a)To pay the plaintiff its fire loss claim in the total amount of
P74,040,518.58 less the amount of P50,505,594.60 (per O.R. No.
3649285) plus deposited in court and damages by way of interest
commencing July 27, 1992 until the time Goyu receives the said
amount at the rate of thirty-seven (37%) percent per annum
which is twice the ceiling prescribed by the Monetary Board.
1. 2.FOR DEFENDANT RIZAL COMMERCIAL BANKING CORPORATION:
1. a)To pay the plaintiff actual and compensatory damages in the
amount of P5,000,000.00.
1. 3.FOR DEFENDANTS MALAYAN INSURANCE CO., INC., RIZAL
COMMERCIAL BANKING CORPORATION, UY CHUN BING AND ELI D.
LAO:
1. a)To pay the plaintiff jointly and severally the following amounts:
1. 1.P1,500,000.00 as exemplary damages;
2. 2.P1,500,000.00 as, and for, attorney’s fees.
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VOL. 289, APRIL 20, 1998 299
Rizal Commercial Banking Corporation vs. Court of Appeals
1. 4.And on RCBC’s Counterclaim, ordering the plaintiff Goyu & Sons,
Inc. to pay its loan obligation with RCBC in the amount of
P68,785,069.04 as of April 27, 1992 without any interest,
surcharges and penalties.
The Clerk of Court of the Regional Trial Court of Manila is hereby ordered to
immediately release to Goyu & Sons, Inc. the amount of P50,505,594.60
(per O.R. No. 3649285) deposited with it by Malayan Insurance Co., Inc.,
together with all the interests thereon.
(Rollo, p. 200.)
RCBC and MICO are now before us in G.R. Nos. 128833 and 128866,
respectively, seeking review and consequent reversal of the above
dispositions of the Court of Appeals.
In G.R. No. 128834, RCBC likewise appeals from the decision in C.A.
G.R. No. CV-48376, which case, by virtue of the Court of Appeals’
resolution dated August 7, 1996, was consolidated with C.A. G.R. No. CV-
46162 (subject of herein G.R. No. 128833). At issue in said petition is
RCBC’s right to intervene in the action between Alfredo C. Sebastian (the
creditor) and GOYU (the debtor), where the subject insurance policies were
attached in favor of Sebastian.
After a careful review of the material facts as found by the two courts
below in relation to the pertinent and applicable laws, we find merit in the
submissions of RCBC and MICO.
The several causes of action pursued below by GOYU gave rise to
several related issues which are now submitted in the petitions before us.
This Court, however, discerns one primary and central issue, and this is,
whether or not RCBC, as mortgagee, has any right over the insurance
policies taken by GOYU, the mortgagor, in case of the occurrence of loss.
As earlier mentioned, accordant with the credit facilities extended by
RCBC to GOYU, the latter executed several mortgage contracts in favor of
RCBC. It was expressly stipulated in these mortgage contracts that GOYU
shall insure the mortgaged property with any of the insurance companies
acceptable to RCBC. GOYU indeed insured the mortgaged property with
MICO, an insurance company acceptable to
300
300 SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Court of Appeals
RCBC. Based on their stipulations in the mortgage contracts, GOYU was
supposed to endorse these insurance policies in favor of, and deliver them,
to RCBC. Alchester Insurance Agency, Inc., MICO’s underwriter from whom
GOYU obtained the subject insurance policies, prepared the nine
endorsements (see Exh. “1-Malayan” to “9-Malayan”; also Exh. “51-RCBC”
to “59-RCBC”), copies of which were delivered to GOYU, RCBC, and MICO.
However, because these endorsements do not bear the signature of any
officer of GOYU, the trial court, as well as the Court of Appeals, concluded
that the endorsements are defective.
We do not quite agree.
It is settled that a mortgagor and a mortgagee have separate and
distinct insurable interests in the same mortgaged property, such that
each one of them may insure the same property for his own sole benefit.
There is no question that GOYU could insure the mortgaged property for its
own exclusive benefit. In the present case, although it appears that GOYU
obtained the subject insurance policies naming itself as the sole payee, the
intentions of the parties as shown by their contemporaneous acts, must be
given due consideration in order to better serve the interest of justice and
equity.
It is to be noted that nine endorsement documents were prepared by
Alchester in favor of RCBC. The Court is in a quandary how Alchester could
arrive at the idea of endorsing any specific insurance policy in favor of any
particular beneficiary or payee other than the insured had not such named
payee or beneficiary been specifically disclosed by the insured itself. It is
also significant that GOYU voluntarily and purposely took the insurance
policies from MICO, a sister company of RCBC, and not just from any other
insurance company. Alchester would not have found out that the subject
pieces of property were mortgaged to RCBC had not such information been
voluntarily disclosed by GOYU itself. Had it not been for GOYU, Alchester
would not have known of GOYU’s intention of obtaining insurance coverage
in compliance with its undertaking in the mortgage contracts with
301
VOL. 289, APRIL 20, 1998 301
Rizal Commercial Banking Corporation vs. Court of Appeals
RCBC, and verily, Alchester would not have endorsed the policies to RCBC
had it not been so directed by GOYU.
On equitable principles, particularly on the ground of estoppel, the
Court is constrained to rule in favor of mortgagee RCBC. The basis and
purpose of the doctrine was explained in Philippine National Bank vs. Court
of Appeals (94 SCRA 357 [1979]), to wit:
The doctrine of estoppel is based upon the grounds of public policy, fair
dealing, good faith and justice, and its purpose is to forbid one to speak
against his own act, representations, or commitments to the injury of one
to whom they were directed and who reasonably relied thereon. The
doctrine of estoppel springs from equitable principles and the equities in
the case. It is designed to aid the law in the administration of justice where
without its aid injustice might result. It has been applied by this Court
wherever and whenever special circumstances of a case so demand.
(p. 368.)
Evelyn Lozada of Alchester testified that upon instructions of Mr. Go,
through a certain Mr. Yam, she prepared in quadruplicate on February 11,
1992 the nine endorsement documents for GOYU’s nine insurance policies
in favor of RCBC. The original copies of each of these nine endorsement
documents were sent to GOYU, and the others were sent to RCBC and
MICO, while the fourth copies were retained for Alchester’s file (tsn,
February 23, pp. 7-8). GOYU has not denied having received from Alchester
the originals of these endorsements.
RCBC, in good faith, relied upon the endorsement documents sent to it
as this was only pursuant to the stipulation in the mortgage contracts. We
find such reliance to be justified under the circumstances of the case.
GOYU failed to seasonably repudiate the authority of the person or persons
who prepared such endorsements. Over and above this, GOYU continued,
in the meantime, to enjoy the benefits of the credit facilities extended to it
by RCBC. After the occurrence of the loss insured against, it was too late
for GOYU to disown the endorsements for any imagined or contrived lack
of authority
302
302 SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Court of Appeals
of Alchester to prepare and issue said endorsements. If there had not been
actually an implied ratification of said endorsements by virtue of GOYU’s
inaction in this case, GOYU is at the very least estopped from assailing
their operative effects. To permit GOYU to capitalize on its non-
confirmation of these endorsements while it continued to enjoy the
benefits of the credit facilities of RCBC which believed in good faith that
there was due endorsement pursuant to their mortgage contracts, is to
countenance grave contravention of public policy, fair dealing, good faith,
and justice. Such an unjust situation, the Court cannot sanction. Under the
peculiar circumstances obtaining in this case, the Court is bound to
recognize RCBC’s right to the proceeds of the insurance policies if not for
the actual endorsement of the policies, at least on the basis of the
equitable principle of estoppel.
GOYU cannot seek relief under Section 53 of the Insurance Code which
provides that the proceeds of insurance shall exclusively apply to the
interest of the person in whose name or for whose benefit it is made. The
peculiarity of the circumstances obtaining in the instant case presents a
justification to take exception to the strict application of said provision, it
having been sufficiently established that it was the intention of the parties declarations, amplifications and limitations established by law, whether the
to designate RCBC as the party for whose benefit the insurance policies estate remains in the possession of the mortgagor, or it passes into the
were taken out. Consider thus the following: hands of a third person.

Significantly, the Court notes that out of the 10 insurance policies subject
1. 1.It is undisputed that the insured pieces of property were the of this case, only 8 of them appear to have
subject of mortgage contracts entered into between RCBC and
304
GOYU in consideration of and for securing GOYU’s credit facilities
from RCBC. The mortgage contracts contained common 304 SUPREME COURT REPORTS ANNOTATED
provisions whereby GOYU, as mortgagor, undertook to have the Rizal Commercial Banking Corporation vs. Court of Appeals
mortgaged property properly covered against any loss by an been subject of the endorsements prepared and delivered by Alchester for
insurance company acceptable to RCBC. and upon instructions of GOYU as shown below:
2. 2.GOYU voluntarily procured insurance policies to cover the
mortgaged property from MICO, no less than a sister company of INSURANCE POLICY PARTICULARS ENDORSEMENT
RCBC and definitely an acceptable insurance company to RCBC. a. Policy Number : F-114-07795 None
     Issue Date : March 18, 1992  
303
     Expiry Date : April 5, 1993  
VOL. 289, APRIL 20, 1998 303
     Amount : P9,646,224.92  
Rizal Commercial Banking Corporation vs. Court of Appeals b. Policy Number : ACIA/F-174-07660 Exhibit “1-
Malayan”
1. 3.Endorsement documents were prepared by MICO’s underwriter,
Alchester Insurance Agency, Inc., and copies thereof were sent to      Issue Date : January 18, 1992  
GOYU, MICO, and RCBC. GOYU did not assail, until of late, the      Expiry Date : February 9, 1993  
validity of said endorsements.
     Amount : P4,307,217.54  
2. 4.GOYU continued until the occurrence of the fire, to enjoy the
benefits of the credit facilities extended by RCBC which was c. Policy Number : ACIA/F-114-07661 Exhibit “2-
conditioned upon the endorsement of the insurance policies to be Malayan”
taken by GOYU to cover the mortgaged properties.
     Issue Date : January 18, 1992  

This Court can not over stress the fact that upon receiving its copies of the      Expiry Date : February 15, 1993  
endorsement documents prepared by Alchester, GOYU, despite the      Amount : P6,603,586.43  
absence of its written conformity thereto, obviously considered said d. Policy Number : ACIA/F-114-07662 Exhibit “3-
endorsement to be sufficient compliance with its obligation under the
mortgage contracts since RCBC accordingly continued to extend the Malayan”
benefits of its credit facilities and GOYU continued to benefit therefrom.      Issue Date : January 18, 1992  
Just as plain too is the intention of the parties to constitute RCBC as the
     Expiry Date : (not legible)  
beneficiary of the various insurance policies obtained by GOYU. The
intention of the parties will have to be given full force and effect in this      Amount : P6,603,586.43  
particular case. The insurance proceeds may, therefore, be exclusively e. Policy Number : ACIA/F-114-07663 Exhibit “4-
applied to RCBC, which under the factual circumstances of the case, is
truly the person or entity for whose benefit the policies were clearly Malayan”
intended.      Issue Date : January 18, 1992  
Moreover, the law’s evident intention to protect the interests of the      Expiry Date : February 9, 1993  
mortgagee upon the mortgaged property is expressed in Article 2127 of
the Civil Code which states:      Amount : P9,457,972.76  
ART. 2127. The mortgage extends to the natural accessions, to the f. Policy Number : ACIA/F-114-07623 Exhibit “7-
improvements, growing fruits, and the rents or income not yet received
Malayan”
when the obligation becomes due, and to the amount of the indemnity
granted or owing to the proprietor from the insurers of the property      Issue Date : January 13, 1992  
mortgaged, or in virtue of expropriation for public use, with the
 INSURANCE POLICY PARTICULARS ENDORSEMENT interest of GOYU in the subject policies had been transferred to RCBC
effective as of the time of the endorsement. These policies may no longer
     Expiry Date : January 13, 1993   be attached by the other creditors of
     Amount : P24,750,000.00   306
g. Policy Number : ACIA/F-174-07223 Exhibit “6- 306 SUPREME COURT REPORTS ANNOTATED
Malayan” Rizal Commercial Banking Corporation vs. Court of Appeals
     Issue Date : May 29, 1991   GOYU, like Alfredo Sebastian in the present G.R. No. 128834, which may
nonetheless forthwith be dismissed for being moot and academic in view of
     Expiry Date : June 27, 1992   the results reached herein. Only the two other policies amounting to
     Amount : P6,000,000.00   P19,646,224.92 may be validly attached, garnished, and levied upon by
305 GOYU’s other creditors. To the extent of GOYU’s outstanding obligation
with RCBC, all the rest of the other insurance policies above-listed which
VOL. 289, APRIL 20, 1998 305
were endorsed to RCBC, are, therefore, to be released from attachment,
Rizal Commercial Banking Corporation vs. Court of Appeals garnishment, and levy by the other creditors of GOYU.
h. Policy Number : CI/F-128-03341 None This brings us to the next relevant issue to be resolved, which is, the
extent of GOYU’s outstanding obligation with RCBC which the proceeds of
     Issue Date : May 3, 1991   the 8 insurance policies will discharge and liquidate, or put differently, the
     Expiry Date : May 3, 1992   actual amount of GOYU’s liability to RCBC.
The Court of Appeals simply echoed the declaration of the trial court
     Amount : P10,000,000.00  
finding that GOYU’s total obligation to RCBC was only P68,785,060.04 as of
i. Policy Number : F-114-07402 Exhibit “8- April 27, 1992, thus sanctioning the trial court’s exclusion of Promissory
Malayan” Note No. 421-92 (renewal of Promissory Note No. 908-91) and Promissory
Note No. 420-92 (renewal of Promissory Note No. 952-91) on the ground
     Issue Date : September 16, 1991   that their execution is highly questionable for not only are these dated
     Expiry Date October 19, 1992   after the fire, but also because the signatures of either GOYU or any of its
     Amount : P32,252,125.20   representative are conspicuously absent. Accordingly, the Court of Appeals
speculated thusly:
j. Policy Number : F-114-07525      Exhibit “9- . . . Hence, this Court is inclined to conclude that said promissory notes
Malayan” were pre-signed by plaintiff in blank terms, as averred by plaintiff, in
contemplation of the speedy grant of future loans, for the same practice of
     Issue Date : November 20, 1991  
procedure has always been adopted in its previous dealings with the bank.
     Expiry Date : December 5, 1992   (Rollo, pp. 181-182.)
     Amount : P6,603,586.43  
The fact that the promissory notes bear dates posterior to the fire does not
(pp. 456-457, Record; Folder of Exhibits for MICO.) necessarily mean that the documents are spurious, for it is presumed that
Policy Number F-114-07795 [(a) above] has not been endorsed. This fact the ordinary course of business had been followed (Metropolitan Bank and
was admitted by MICO’s witness, Atty. Farolan (tsn, February 16, 1994, p. Trust Company vs. Quilts and All, Inc., 222 SCRA 486 [1993]). The obli-
25). Likewise, the record shows no endorsement for Policy Number CI/F- 307
128-03341 [(h) above]. Also, one of the endorsement documents, Exhibit
“5-Malayan,” refers to a certain insurance policy number ACIAF-07066, VOL. 289, APRIL 20, 1998 307
which is not among the insurance policies involved in the complaint. Rizal Commercial Banking Corporation vs. Court of Appeals
The proceeds of the 8 insurance policies endorsed to RCBC aggregate gor and not the holder of the negotiable instrument has the burden of
to P89,974,488.36. Being exclusively payable to RCBC by reason of the proof of showing that he no longer owes the obligee any amount (Travel-
endorsement by Alchester to RCBC, which we already ruled to have the On, Inc. vs. Court of Appeals, 210 SCRA 351 [1992]).
force and effect of an endorsement by GOYU itself, these 8 policies can not Even casting aside the presumption of regularity of private
be attached by GOYU’s other creditors up to the extent of the GOYU’s transactions, receipt of the loan amounting to P121,966,058.67 (Exhibits 1-
outstanding obligation in RCBC’s favor. Section 53 of the Insurance Code 29, RCBC) was admitted by GOYU as indicated in the testimony of Go Song
ordains that the insurance proceeds of the endorsed policies shall be Hiap when he answered the queries of the trial court:
applied exclusively to the proper interest of the person for whose benefit it
ATTY. NATIVIDAD
was made. In this case, to the extent of GOYU’s obligation with RCBC, the
Q But insofar as the amount stated in Exhibits 1 to 29- RCBC, you received all the
 : amounts stated therein?
A Yes, sir, I received the amount.
: represented by these promissory notes were admittedly received by GOYU.
COURT
  He is asking if he received all the amounts stated in Exhibits 1 to 29-RCBC?
WITNESS
  Yes, Your Honor, I received all the amounts.
COURT
  Indicated in the Promissory Notes?
WITNESS
A The promissory Notes they did not give to me but the amount I asked which is
: correct, Your Honor.
COURT
Q You mean to say the amounts indicated in Exhibits 1 to 29-RCBC is correct?
:
A Yes, Your Honor.
: 27,548,025.17 ____________ Total: 108,083,971.49 8,218,021.11 2 LESS: 1)
  (tsn, Jan. 14, 1994, p. 26.)
Furthermore, aside from its judicial admission of having received all the
proceeds of the 29 promissory notes as hereinabove quoted, GOYU also
offered and admitted to RCBC that its obligation be fixed at
P116,301,992.60 as shown in its letter dated March 9, 1993, which
pertinently reads:
We wish to inform you, therefore that we are ready and willing to pay the
current past due account of this company in the amount of
308
308 SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Court of Appeals
P116,301,992.60 as of 21 January 1993, specified in pars. 15, p. 10, and
18, p. 13 of your affidavits of Third Party Claims in the Urban case at
Makati, Metro Manila and in the Zamboanga case at Zamboanga City,
respectively, less the total of P8,851,519.71 paid from the Seaboard and
Equitable insurance companies and other legitimate deductions. We accept
and confirm this amount of P116,301,992.60 as stated as true and correct.
(Exhibit BB.)
The Court of Appeals erred in placing much significance on the fact that
the excluded promissory notes are dated after the fire. It failed to consider
that said notes had for their origin transactions consummated prior to the
fire. Thus, careful attention must be paid to the fact that Promissory Notes
Nos. 420-92 and 421-92 are mere renewals of Promissory Notes Nos. 908-
91 and 952-91, loans already availed of by GOYU.
The two courts below erred in failing to see that the promissory notes
which they ruled should be excluded for bearing dates which are after that
of the fire, are mere renewals of previous ones. The proceeds of the loan
There is ample factual and legal basis for giving GOYU’s judicial admission
of liability in the amount of P116,301,992.60 full force and effect.
It should, however, be quickly added that whatever amount RCBC may
have recovered from the other insurers of the mortgaged property will,
nonetheless, have to be applied as payment against GOYU’s obligation.
But, contrary to the lower courts’ findings, payments effected by GOYU
prior to January 21, 1993 should no longer be deducted. Such payments
had obviously been duly considered by GOYU, in its aforequoted letter
dated March 9, 1993, wherein it admitted that its past due account totaled
P116,301,992.60 as of January 21, 1993.
The net obligation of GOYU, after deductions, is thus reduced to
P107,246,887.90 as of January 21, 1993, to wit:
309
VOL. 289, APRIL 20, 1998 309
Rizal Commercial Banking Corporation vs. Court of Appeals
  Total Obligation as admitted by GOYU as of January 21, 1993: P116,301,992.60  
Broken down as follows: Principal 1 Interest Regular 80,535,946.32 FDU
Proceeds from Seaboard Eastern Insurance Company: 6,095,145.81 2)
Proceeds from Equitable Insurance Company: 2,756,373.00 3) Payment
from foreign department negotiation: 203,584.89 9,055,104.70 3 NET
AMOUNT as of January 21, 1993: P107,246,887.90
The need for the payment of interest due upon the principal amount of
the obligation, which is the cost of money to RCBC, the primary end and
the ultimate reason for RCBC’s existence and being, was duly recognized
by the trial court when it ruled favorably on RCBC’s counterclaim, ordering
GOYU “to pay its loan obligation with RCBC in the amount of
________________
1
 See: Exhibit “70-RCBC.”
2
 Computed by deducting P108,083,971.49 from the admitted amount
of P116,301,992.60.
3
 To be deducted from interest payments due in accordance with Article
1253 of the Civil Code which provides: ART. 1253. If debt produces
interest, payment of the principal shall not be deemed to have been made
until the interests have been covered.
310
310 SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Court of Appeals
P68,785,069.04, as of April 27, 1992, with interest thereon at the rate
stipulated in the respective promissory notes (without surcharges and
penalties) per computation, pp. 14-A, 14-B, 14-C” (Record, p. 479).
Inexplicably, the Court of Appeals, without even laying down the factual or
legal justification for its ruling, modified the trial court’s ruling and ordered
GOYU “to pay the principal amount of P68,785,069.04 without any
interest, surcharges and penalties” (Rollo, p. 200).
It is to be noted in this regard that even the trial court hedgingly and
with much uncertainty deleted the payment of additional interest,
penalties, and charges, in this manner:
Regarding defendant RCBC’s commitment not to charge additional
interest, penalties and surcharges, the same does not require that it be
embodied in a document or some form of writing to be binding and
enforceable. The principle is well known that generally a verbal agreement
or contract is no less binding and effective than a written one. And the
existence of such a verbal agreement has been amply established by the
evidence in this case. In any event, regardless of the existence of such
verbal agreement, it would still be unjust and inequitable for defendant
RCBC to charge the plaintiff with surcharges and penalties considering the
latter’s pitiful situation. (Emphasis supplied.)
(Record, p. 476)
The essence or rationale for the payment of interest or cost of money is
separate and distinct from that of surcharges and penalties. What may
justify a court in not allowing the creditor to charge surcharges and
penalties despite express stipulation therefor in a valid agreement, may
not equally justify non-payment of interest. The charging of interest for
loans forms a very essential and fundamental element of the banking
business, which may truly be considered to be at the very core of its
existence or being. It is inconceivable for a bank to grant loans for which it
will not charge any interest at all. We fail to find justification for the Court
of Appeals’ outright deletion of the payment of interest as agreed upon in
the respective promissory notes. This constitutes gross error.
311
VOL. 289, APRIL 20, 1998 311
Rizal Commercial Banking Corporation vs. Court of Appeals
For the computation of the interest due to be paid to RCBC, the following
rules of thumb laid down by this Court in Eastern Shipping Lines, Inc. vs.
Court of Appeals (234 SCRA 78 [1994]), shall apply, to wit:
1. I.When an obligation, regardless of its source, i.e., law, contracts,
quasi-contracts, delicts or quasi-delicts is breached, the
contravenor can be held liable for damages. The provisions under
Title XVIII on “Damages” of the Civil Code govern in determining
the measure of recoverable damages.
2. II.With regard particularly to an award of interest in the concept of
actual and compensatory damages, the rate of interest, as well as
the accrual thereof, is imposed, as follows:
1. 1.When the obligation is breached, and it consists in the payment
of a sum of money, i.e., a loan or forbearance of money, the
interest due should be that which may have been stipulated in
writing. Furthermore, the interest due shall itself earn legal
interest from the time it is judicially demanded. In the absence of
stipulation, the rate of interest shall be 12% per annum to be
computed from default, i.e., from judicial or extrajudicial demand
under and subject to the provisions of Article 1169 of the Civil
Code.
2. 2.When an obligation, not constituting a loan or forbearance of
money, is breached, an interest on the amount of damages
awarded may be imposed at the discretion of the court at the rate
of 6% per annum. No interest, however, shall be adjudged on
unliquidated claims or damages except when or until the demand
can be established with reasonable certainty. Accordingly, where
the demand is established with reasonable certainty, the interest
shall begin to run from the time the claim is made judicially or
extrajudicially (Art. 1169, Civil Code) but when such certainty
cannot be so reasonably established at the time the demand is
made, the interest shall begin to run only from the date of the
judgment of the court is made (at which time the quantification of
damages may be deemed to have been reasonably ascertained).
The actual base for the computation of legal interest shall, in any
case, be on the amount finally adjudged.
3. 3.When the judgment of the court awarding a sum of money
becomes final and executory, the rate of legal interest, whether
the case falls under paragraph 1 or paragraph 2, above, shall be
12% per annum from such finality until its satisfaction, this
interim period being deemed to be by then an equivalent to a
forbearance of credit.
(pp. 95-97.)
312
312 SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Court of Appeals
There being written stipulations as to the rate of interest owing on each
specific promissory note as summarized and tabulated by the trial court in
its decision (pp. 470 and 471, Record) such agreed interest rates must be
followed. This is very clear from paragraph II, sub-paragraph 1 quoted
above.
On the issue of payment of surcharges and penalties, we partly agree
that GOYU’s pitiful situation must be taken into account. We do not agree,
however, that payment of any amount as surcharges and penalties should
altogether be deleted. Even assuming that RCBC, through its responsible
officers, herein petitioners Eli Lao and Uy Chun Bing, may have relayed its
assurance for assistance to GOYU immediately after the occurrence of the
fire, we cannot accept the lower courts’ finding that RCBC had thereby ipso
facto effectively waived collection of any additional interests, surcharges,
and penalties from GOYU. Assurances of assistance are one thing, but
waiver of additional interests, surcharges, and penalties is another.
Surcharges and penalties agreed to be paid by the debtor in case of
default partake of the nature of liquidated damages, covered by Section 4,
Chapter 3, Title XVIII of the Civil Code. Article 2227 thereof provides:
ART. 2227. Liquidated damages, whether intended as an indemnity or
penalty, shall be equitably reduced if they are iniquitous and
unconscionable.
In exercising this vested power to determine what is iniquitous and
unconscionable, the Court must consider the circumstances of each case.
It should be stressed that the Court will not make any sweeping ruling that
surcharges and penalties imposed by banks for non-payment of the loans
extended by them are generally iniquitous and unconscionable. What may
be iniquitous and unconscionable in one case, may be totally just and
equitable in another. This provision of law will have to be applied to the
established facts of any given case. Given the circumstances under which
GOYU found itself after the occurrence of the fire, the Court rules the
surcharges rates
313
VOL. 289, APRIL 20, 1998 313
Rizal Commercial Banking Corporation vs. Court of Appeals
ranging anywhere from 9% to 27%, plus the penalty charges of 36%, to be
definitely iniquitous and unconscionable. The Court tempers these rates to
2% and 3%, respectively. Furthermore, in the light of GOYU’s offer to pay
the amount of P116,301,992.60 to RCBC as of March 1993 (See: Exhibit
“BB”), which RCBC refused, we find it more in keeping with justice and
equity for RCBC not to charge additional interest, surcharges, and
penalties from that time onward.
Given the factual milieu spread hereover, we rule that it was error to
hold MICO liable in damages for denying or withholding the proceeds of the
insurance claim to GOYU.
Firstly, by virtue of the mortgage contracts as well as the endorsements
of the insurance policies, RCBC has the right to claim the insurance
proceeds, in substitution of the property lost in the fire. Having assigned its
rights, GOYU lost its standing as the beneficiary of the said insurance
policies.
Secondly, for an insurance company to be held liable for unreasonably
delaying and withholding payment of insurance proceeds, the delay must
be wanton, oppressive, or malevolent (Zenith Insurance Corporation vs.
CA, 185 SCRA 403 [1990]). It is generally agreed, however, that an insurer
may in good faith and honesty entertain a difference of opinion as to its
liability. Accordingly, the statutory penalty for vexatious refusal of an
insurer to pay a claim should not be inflicted unless the evidence and
circumstances show that such refusal was willful and without reasonable
cause as the facts appear to a reasonable and prudent man (Buffalo Ins.
Co. vs. Bommarito [CCA 8th] 42 F [2d] 53, 70 ALR 1211; Phoenix Ins. Co.
vs. Clay, 101 Ga. 331, 28 SE 853, 65 Am St Rep 307; Kusnetsky vs.
Security Ins. Co., 313 Mo. 143, 281 SW 47, 45 ALR 189). The case at bar
does not show that MICO wantonly and in bad faith delayed the release of
the proceeds. The problem in the determination of who is the actual
beneficiary of the insurance policies, aggravated by the claim of various
creditors who wanted to partake of the insurance proceeds, not to mention
the importance of the endorsement to RCBC, to our mind, and as now
borne out by the outcome herein, justified MICO in withholding payment to
GOYU.
314
314 SUPREME COURT REPORTS ANNOTATED
Rizal Commercial Banking Corporation vs. Court of Appeals
In adjudging RCBC liable in damages to GOYU, the Court of Appeals said
that RCBC cannot avail itself of two simultaneous remedies in enforcing the
claim of an unpaid creditor, one for specific performance and the other for
foreclosure. In doing so, said the appellate court, the second action is
deemed barred, RCBC having split a single cause of action (Rollo, pp. 195-
199). The Court of Appeals was too accommodating in giving due
consideration to this argument of GOYU, for the foreclosure suit is still
pending appeal before the same Court of Appeals in CA G.R. CV No. 46247,
the case having been elevated by RCBC.
In finding that the foreclosure suit cannot prosper, the Fifteenth
Division of the Court of Appeals pre-empted the resolution of said
foreclosure case which is not before it. This is plain reversible error if not
grave abuse of discretion.
As held in Peña vs. Court of Appeals (245 SCRA 691 [1995]):
It should have been enough, nonetheless, for the appellate court to merely
set aside the questioned orders of the trial court for having been issued by
the latter with grave abuse of discretion. In likewise enjoining permanently
herein petitioner “from entering in and interfering with the use or
occupation and enjoyment of petitioner’s (now private respondent)
residential house and compound,” the appellate court in effect,
precipitately resolved with finality the case for injunction that was yet to be
heard on the merits by the lower court. Elevated to the appellate court, it
might be stressed, were mere incidents of the principal case still pending
with the trial court. In Municipality of Biñan, Laguna vs. Court of
Appeals, 219 SCRA 69, we ruled that the Court of Appeals would have “no
jurisdiction in a certiorari proceeding involving an incident in a case to rule
on the merits of the main case itself which was not on appeal before it.”
(pp. 701-702.)
Anent the right of RCBC to intervene in Civil Case No. 1073, before the
Zamboanga Regional Trial Court, since it has been determined that RCBC
has the right to the insurance proceeds, the subject matter of intervention
is rendered moot
315
VOL. 289, APRIL 20, 1998 315
Rizal Commercial Banking Corporation vs. Court of Appeals
and academic. Respondent Sebastian must, however, yield to the
preferential right of RCBC over the MICO insurance policies. It is basic and
fundamental that the first mortgagee has superior rights over junior
mortgagees or attaching creditors (Alpha Insurance & Surety Co. vs.
Reyes, 106 SCRA 274 [1981]; Sun Life Assurance Co. of Canada vs.
Gonzales Diaz, 52 Phil. 271 [1928]).
WHEREFORE, the petitions are hereby GRANTED and the decision and
resolution of December 16, 1996 and April 3, 1997 in CA-G.R. CV No.
46162 are hereby REVERSED and SET ASIDE, and a new one entered:
 1. 1.Dismissing the Complaint of private respondent GOYU in Civil
Case No. 93-65442 before Branch 3 of the Manila Regional Trial
Court for lack of merit;
2. 2.Ordering Malayan Insurance Company, Inc. to deliver to Rizal
Commercial Banking Corporation the proceeds of the insurance
policies in the amount of P51,862,390.94 (per report of adjuster
Toplis & Harding [Far East], Inc., Exhibits “2” and “2-1”), less the
amount of P50,505,594.60 (per O.R. No. 3649285);
3. 3.Ordering the Clerk of Court to release the amount of
P50,505,594.60 including the interests earned to Rizal
Commercial Banking Corporation;
4. 4.Ordering Goyu & Sons, Inc. to pay its loan obligation with Rizal
Commercial Banking Corporation in the principal amount of
P107,246,887.90, with interest at the respective rates stipulated
in each promissory note from January 21, 1993 until finality of this
judgment, and surcharges at 2% and penalties at 3% from
January 21, 1993 to March 9, 1993, minus payments made by
Malayan Insurance Company, Inc. and the proceeds of the
amount deposited with the trial court and its earned interest. The
total amount due RCBC at the time of the finality of this judgment
shall earn interest at the legal rate of 12% in lieu of all other
stipulated interests and charges until fully paid.

The petition of Rizal Commercial Banking Corporation against the

respondent Court in CA-GR CV 48376 is DISMISSED for being moot and
academic in view of the results
316
316 SUPREME COURT REPORTS ANNOTATED
People vs. Tulop
herein arrived at. Respondent Sebastian’s right as attaching creditor must
yield to the preferential rights of Rizal Commercial Banking Corporation
over the Malayan insurance policies as first mortgagee.
SO ORDERED.
     Regalado (Chairman), Puno, Mendoza and Martinez, JJ., concur.

Petitions granted, decision and resolution reversed and set aside.

Note.—Where both parties offer a conflicting interpretation of a
contract then judicial determination of the parties’ intention is inevitable.
(China Banking Corporation vs. Court of Appeals, 265 SCRA 327 [1996])

——o0o——
560 SUPREME COURT REPORTS ANNOTATED
Ligutan vs. Court of Appeals
G.R. No. 138677. February 12, 2002.*
TOLOMEO LIGUTAN and LEONIDAS DE LA LLANA, petitioners, vs. HON.
COURT OF APPEALS & SECURITY BANK & TRUST COMPANY, respondents.
Obligations and Contracts; Penalty Clauses; Words and Phrases; A
penalty clause, expressly recognized by law, is an accessory undertaking
to assume greater liability on the part of an obligor in case of breach of an
_______________
*
 THIRD DIVISION.
561
VOL. 376, FEBRUARY 12, 2002 561
Ligutan vs. Court of Appeals
obligation; Although a court may not at liberty ignore the freedom of
the parties to agree on such terms and conditions as they see fit that
contravene neither law nor morals, good customs, public order or public
policy, a stipulated penalty, nevertheless, may be equitably reduced by
the courts if it is iniquitous or unconscionable or if the principal obligation
has been partly or irregularly complied with.—A penalty clause, expressly
recognized by law, is an accessory undertaking to assume greater liability
on the part of an obligor in case of breach of an obligation. It functions to
strengthen the coercive force of the obligation and to provide, in effect, for
what could be the liquidated damages resulting from such a breach. The
obligor would then be bound to pay the stipulated indemnity without the
necessity of proof on the existence and on the measure of damages
caused by the breach. Although a court may not at liberty ignore the
freedom of the parties to agree on such terms and conditions as they see
fit that contravene neither law nor morals, good customs, public order or
public policy, a stipulated penalty, nevertheless, may be equitably reduced
by the courts if it is iniquitous or unconscionable or if the principal
obligation has been partly or irregularly complied with.
Same; Same; The question of whether a penalty is reasonable or
iniquitous can be partly subjective and partly objective.—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. In Rizal Commercial Banking Corp. vs. Court of
Appeals, just an example, the Court has tempered the penalty charges
after taking into account the debtor’s pitiful situation and its offer to settle
the entire obligation with the creditor bank. The stipulated penalty might
likewise be reduced when a partial or irregular performance is made by the
debtor. The stipulated penalty might even be deleted such as when there
has been substantial performance in good faith by the obligor, when the
penalty clause itself suffers from fatal infirmity, or when exceptional
circumstances so exist as to warrant it.
Same; Same; Interests; The essence or rationale for the payment of
interest, quite often referred to as cost of money, is not exactly the same
as that of a surcharge or a penalty, and 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; What
may justify a court in not allowing the creditor to impose full surcharges
and
562
562 SUPREME COURT REPORTS ANNOTATED
Ligutan vs. Court of Appeals
penalties, despite an express stipulation therefor in a valid
agreement, may not equally justify the non-payment or reduction of
interest.—Anent the stipulated interest of 15.189% per annum, petitioners,
for the first time, question its reasonableness and prays that the Court
reduce the amount. This contention is a fresh issue that has not been
raised and ventilated before the courts below. In any event, the interest
stipulation, on its face, does not appear as being that excessive. The
essence or rationale for the payment of interest, quite often referred to as
cost of money, is 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. What may justify a court in not allowing the
creditor to impose full surcharges and penalties, despite an express
stipulation therefor in a valid agreement, may not equally justify the non-
payment or reduction of interest. Indeed, the interest prescribed in loan
financing arrangements is a fundamental part of the banking business and
the core of a bank’s existence.
Same; Attorney’s Fees; Where the rate of attorney’s fees has been
agreed to by the parties and intended to answer not only for litigation
expenses but also for collection efforts as well, an award of 10% attorney’s
fees is reasonable.—Petitioners next assail the award of 10% of the total
amount of indebtedness by way of attorney’s fees for being grossly
excessive, exorbitant and unconscionable vis-a-vis the time spent and the
extent of services rendered by counsel for the bank and the nature of the
case. Bearing in mind that the rate of attorney’s fees has been agreed to
by the parties and intended to answer not only for litigation expenses but
also for collection efforts as well, the Court, like the appellate court, deems
the award of 10% attorney’s fees to be reasonable.
Same; Novation; Requisites; In order that an obligation may be
extinguished by another which substitutes the same, it is imperative that it
be so declared in unequivocal terms, or that the old and the new obligation
be on every point incompatible with each other; When not expressed,
incompatibility is required so as to ensure that the parties have indeed
intended such novation despite their failure to express it in categorical
terms.—Extinctive novation requires, first, a previous valid
obligation; second, the agreement of all the parties to the new
contract; third, the extinguishment of the obligation; and fourth, the
validity of the new one. In order that an obligation may be extinguished by
another which substitutes the same, it is imperative that it be so declared
in unequivocal terms, or that the old and the new obligation be on every
point incompatible with each other. An obligation to pay a sum of money is
not extinctively novated by a new instrument which merely changes the
terms of payment or adding com-
563
VOL. 376, FEBRUARY 12, 2002 563
Ligutan vs. Court of Appeals
patible covenants or where the old contract is merely supplemented
by the new one. When not expressed, incompatibility is required so as to
ensure that the parties have indeed intended such novation despite their
failure to express it in categorical terms. The incompatibility, to be sure,
should take place in any of the essential elements of the obligation, i.e., (1)
the juridical relation or tie, such as from a mere commodatum to lease of
things, or from negotiorum gestio to agency, or from a mortgage to
antichresis, or from a sale to one of loan; (2) the object or principal
conditions, such as a change of the nature of the prestation; or (3) the
subjects, such as the substitution of a debtor or the subrogation of the
creditor. Extinctive novation does not necessarily imply that the new
agreement should be complete by itself; certain terms and conditions may
be carried, expressly or by implication, over to the new obligation.
PETITION for review on certiorari of a decision of the Court of Appeals.
The facts are stated in the opinion of the Court.
     Florimond C. Rous for petitioners.
     Castro, Biñas, Samillano & Mangrobang for Security Bank & Trust
Co.
VITUG, J.:
Before the Court is a petition for review on certiorari under Rule 45 of the
Rules of Court, assailing the decision and resolutions of the Court of
Appeals in CA-G.R. CV No. 34594, entitled “Security Bank and Trust Co. vs.
Tolomeo Ligutan, et al.”
Petitioners Tolomeo Ligutan and Leonidas dela Llana obtained on 11
May 1981 a loan in the amount of P120,000.00 from respondent Security
Bank and Trust Company. Petitioners executed a promissory note binding
themselves, jointly and severally, to pay the sum borrowed with an interest
of 15.189% per annum upon maturity and to pay a penalty of 5% every
month on the outstanding principal and interest in case of default. In
addition, petitioners agreed to pay 10% of the total amount due by way of
attorney’s fees if the matter were indorsed to a lawyer for collection or if a
suit were instituted to enforce payment. The obligation matured on 8
September 1981; the bank, however, granted an extension but only up
until 29 December 1981.
564
564 SUPREME COURT REPORTS ANNOTATED
Ligutan vs. Court of Appeals
Despite several demands from the bank, petitioners failed to settle the
debt which, as of 20 May 1982, amounted to P114,416.10. On 30
September 1982, the bank sent a final demand letter to petitioners
informing them that they had five days within which to make full payment.
Since petitioners still defaulted on their obligation, the bank filed on 3
November 1982, with the Regional Trial Court of Makati, Branch 143, a
complaint for recovery of the due amount.
After petitioners had filed a joint answer to the complaint, the bank
presented its evidence and, on 27 March 1985, rested its case. Petitioners,
instead of introducing their own evidence, had the hearing of the case
reset on two consecutive occasions. In view of the absence of petitioners
and their counsel on 28 August 1985, the third hearing date, the bank
moved, and the trial court resolved, to consider the case submitted for
decision.
Two years later, or on 23 October 1987, petitioners filed a motion for
reconsideration of the order of the trial court declaring them as having
waived their right to present evidence and prayed that they be allowed to
prove their case. The court a quo denied the motion in an order, dated 5
September 1988, and on 20 October 1989, it rendered its decision, 1 the
dispositive portion of which read:
“WHEREFORE, judgment is hereby rendered in favor of the plaintiff and
against the defendants, ordering the latter to pay, jointly and severally, to
the plaintiff, as follows:
1. “1.The sum of P114,416.00 with interest thereon at the rate of
15.189% per annum, 2% service charge and 5% per month
penalty charge, commencing on 20 May 1982 until fully paid;
2. “2.To pay the further sum equivalent to 10% of the total amount of
indebtedness for and as attorney’s fees; and
3. “3.To pay the costs of the suit.”2
Petitioners interposed an appeal with the Court of Appeals, questioning the
rejection by the trial court of their motion to pres-
_______________
1
 Rollo, p. 114.
2
 Rollo, pp. 117-118.
565
VOL. 376, FEBRUARY 12, 2002 565
Ligutan vs. Court of Appeals
ent evidence and assailing the imposition of the 2% service charge, the 5%
per month penalty charge and 10% attorney’s fees. In its decision 3 of 7
March 1996, the appellate court affirmed the judgment of the trial court
except on the matter of the 2% service charge which was deleted pursuant
to Central Bank Circular No. 783. Not fully satisfied with the decision of the
appellate court, both parties filed their respective motions for
reconsideration.4 Petitioners prayed for the reduction of the 5% stipulated
penalty for being unconscionable. The bank, on the other hand, asked that
the payment of interest and penalty be commenced not from the date of
filing of complaint but from the time of default as so stipulated in the
contract of the parties.
On 28 October 1998, the Court of Appeals resolved the two motions
thusly:
“We find merit in plaintiff-appellee’s claim that the principal sum of
P114,416.00 with interest thereon must commence not on the date of filing
of the complaint as we have previously held in our decision but on the date
when the obligation became due.
“Default generally begins from the moment the creditor demands the
performance of the obligation. However, demand is not necessary to
render the obligor in default when the obligation or the law so provides.
“In the case at bar, defendants-appellants executed a promissory note
where they undertook to pay the obligation on its maturity date ‘without
necessity of demand.’ They also agreed to pay the interest in case of non-
payment from the date of default.
“x x x      x x x      x x x
“While we maintain that defendants-appellants must be bound by the
contract which they acknowledged and signed, we take cognizance of their
plea for the application of the provisions of Article 1229 x x x.
“Considering that defendants-appellants partially complied with their
obligation under the promissory note by the reduction of the original
amount of P120,000.00 to P114,416.00 and in order that they will finally
settle their obligation, it is our view and we so hold that in the interest of
justice and public policy, a penalty of 3% per month or 36% per annum
would suffice.
_______________
3
 Rollo, p. 39.
4
 Rollo, pp. 55, 58.
566
566 SUPREME COURT REPORTS ANNOTATED
Ligutan vs. Court of Appeals
“x x x      x x x      x x x
“WHEREFORE, the decision sought to be reconsidered is hereby
MODIFIED. The defendants-appellants Tolomeo Ligutan and Leonidas dela
Llana are hereby ordered to pay the plaintiff-appellee Security Bank and
Trust Company the following:
1. “1.The sum of P114,416.00 with interest thereon at the rate of
15.189% per annum and 3% per month penalty charge
commencing May 20, 1982 until fully paid;
2. “2.The sum equivalent to 10% of the total amount of the
indebtedness as and for attorney’s fees.”5
On 16 November 1998, petitioners filed an omnibus motion for
reconsideration and to admit newly-discovered evidence, 6 alleging that
while the case was pending before the trial court, petitioner Tolomeo
Ligutan and his wife Bienvenida Ligutan executed a real estate mortgage
on 18 January 1984 to secure the existing indebtedness of petitioners
Ligutan and dela Llana with the bank. Petitioners contended that the
execution of the real estate mortgage had the effect of novating the
contract between them and the bank. Petitioners further averred that the
mortgage was extrajudicially foreclosed on 26 August 1986, that they were
not informed about it, and the bank did not credit them with the proceeds
of the sale. The appellate court denied the omnibus motion for
reconsideration and to admit newly-discovered evidence, ratiocinating that
such a second motion for reconsideration cannot be entertained under
Section 2, Rule 52, of the 1997 Rules of Civil Procedure. Furthermore, the
appellate court said, the newly-discovered evidence being invoked by
petitioners had actually been known to them when the case was brought
on appeal and when the first motion for reconsideration was filed. 7
Aggrieved by the decision and resolutions of the Court of Appeals,
petitioners elevated their case to this Court on 9 July 1999 via a petition for
review on certiorari under Rule 45 of the Rules of Court, submitting thusly
—
_______________
5
 Rollo, pp. 48-49.
6
 Rollo, p. 67.
7
 Rollo, p. 52.
567
VOL. 376, FEBRUARY 12, 2002 567
Ligutan vs. Court of Appeals
1. “I.The respondent Court of Appeals seriously erred in not holding
that the 15.189% interest and the penalty of three (3%) percent
per month or thirty-six (36%) percent per annum imposed by
private respondent bank on petitioners’ loan obligation are still
manifestly exhorbitant, iniquitous and unconscionable.
2. “II.The respondent Court of Appeals gravely erred in not reducing
to a reasonable level the ten (10%) percent award of attorney’s
fees which is highly and grossly excessive, unreasonable and
unconscionable.
3. “III.The respondent Court of Appeals gravely erred in not admitting
petitioners’ newly discovered evidence which could not have
been timely produced during the trial of this case.
4. “IV.The respondent Court of Appeals seriously erred in not holding
that there was a novation of the cause of action of private
respondent’s complaint in the instant case due to the subsequent
execution of the real estate mortgage during the pendency of this
case and the subsequent foreclosure of the mortgage.” 8

Respondent bank, which did not take an appeal, would, however, have it
that the penalty sought to be deleted by petitioners was even insufficient
to fully cover and compensate for the cost of money brought about by the
radical devaluation and decrease in the purchasing power of the peso,
particularly vis-a-vis the U.S. dollar, taking into account the time frame of
its occurrence. The Bank would stress that only the amount of P5,584.00
had been remitted out of the entire loan of P120,000.00. 9
A penalty clause, expressly recognized by law,10 is an accessory
undertaking to assume greater liability on the part of an obligor in case of
breach of an obligation. It functions to strengthen the coer-
_______________
8
 Rollo, pp. 17-18.
9
 Memorandum for Respondent.
10
 Art. 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. (1152a)
568
568 SUPREME COURT REPORTS ANNOTATED
Ligutan vs. Court of Appeals
cive force of the obligation 11 and to provide, in effect, for what could be the
liquidated damages resulting from such a breach. The obligor would then
be bound to pay the stipulated indemnity without the necessity of proof on
the existence and on the measure of damages caused by the
breach.12 Although a court may not at liberty ignore the freedom of the
parties to agree on such terms and conditions as they see fit that
contravene neither law nor morals, good customs, public order or public
policy, a stipulated penalty, nevertheless, may be equitably reduced by the
courts if it is iniquitous or unconscionable or if the principal obligation has
been partly or irregularly complied with.13
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. In Rizal Commercial
Banking Corp. vs. Court of Appeals,14 just an example, the Court has
tempered the penalty charges after taking into account the debtor’s pitiful
situation and its offer to settle the entire obligation with the creditor bank.
The stipulated penalty might likewise be reduced when a partial or
irregular performance is made by the debtor.15 The stipulated pen-
_______________
11
 SSS vs. Moonwalk Development and Housing Corporation, 221 SCRA
119.
12
 Article 1228, Civil Code; Manila Racing Club vs. Manila Jockey
Club, 69 Phil. 55.
13
 Article 2227. Liquidated damages, whether intended as an indemnity
or a penalty, shall be equitably reduced if they are iniquitous or
unconscionable.
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.
14
 289 SCRA 292 (1998).
15
 Insular Bank of Asia and America vs. Spouses Salazar (159 SCRA
111), for instance, the Court reduced the penalty charge of 2% a month to
1% a month, considering that, on a loan of P42,050.00, the debtor spouses
569
VOL. 376, FEBRUARY 12, 2002 569
Ligutan vs. Court of Appeals
alty might even be deleted such as when there has been substantial
performance in good faith by the obligor, 16 when the penalty clause itself
suffers from fatal infirmity, or when exceptional circumstances so exist as
to warrant it.17
The Court of Appeals, exercising its good judgment in the instant case,
has reduced the penalty interest from 5% a month to 3% a month which
petitioner still disputes. Given the circumstances, not to mention the
repeated acts of breach by petitioners of their contractual obligation, the
Court sees no cogent ground to modify the ruling of the appellate court.
Anent the stipulated interest of 15.189% per annum, petitioners, for the
first time, question its reasonableness and prays that the Court reduce the
amount. This contention is a fresh issue that has not been raised and
ventilated before the courts below. In any event, the interest stipulation,
on its face, does not appear as being that excessive. The essence or
rationale for the payment of interest, quite often referred to as cost of
money, is 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.18 What may justify a court in not allowing the
creditor to impose full surcharges and penalties, despite an express
stipulation therefor in a valid agreement, may not equally justify the non-
payment or reduction of interest. Indeed, the interest prescribed in loan
financing arrangements is a fundamental part of the banking business and
the core of a bank’s existence. 19
_______________
paid a total of P68,676.75 which was applied by the creditor to satisfy
the penalty and interest charges.
16
 Art. 1234. 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.
 17
 Garcia vs. Court of Appeals, 167 SCRA 815 (1988); See Palmares vs.
Ligutan vs. Court of Appeals
Court of Appeals, 288 SCRA 423 (1998); Ibarra vs. Aveyro, 37 Phil. 278.
18 extinguishment of the original contract of loan because of novation.
 Insular Bank of Asia and America vs. Spouses Salazar, 159 SCRA
Petitioners acknowledge that the real estate mortgage contract does not
133 (1988); GSIS vs. Court of Appeals, 145 SCRA 311 (1986); Equitable
contain any express stipulation by the parties intending it to supersede the
Banking Corporation vs. Liwanag, 32 SCRA 293 (1970).
19 existing loan agreement between the petitioners and the
 Rizal Commercial Banking Corporation vs. Court of Appeals, 289
bank.21 Respondent bank has correctly postulated that the mortgage is but
SCRA 292 (1998).
an accessory contract to secure the loan in the promissory note.
570 Extinctive novation requires, first, a previous valid
obligation; second, the agreement of all the parties to the new
570 SUPREME COURT REPORTS ANNOTATED contract; third, the extinguishment of the obligation; and fourth, the
Ligutan vs. Court of Appeals validity of the new one.22 In order that an obligation may be extinguished
Petitioners next assail the award of 10% of the total amount of by another which substitutes the same, it is imperative that it be so
indebtedness by way of attorney’s fees for being grossly excessive, declared in unequivocal terms, or that the old and the new obligation be on
exorbitant and unconscionable vis-a-vis the time spent and the extent of every point incompatible with each other. 23 An obligation to pay a sum of
services rendered by counsel for the bank and the nature of the case. money is not extinctively novated by a new instrument which merely
Bearing in mind that the rate of attorney’s fees has been agreed to by the changes the terms of payment or adding compatible covenants or where
parties and intended to answer not only for litigation expenses but also for the old contract is merely supplemented by the new one. 24 When not
collection efforts as well, the Court, like the appellate court, deems the expressed, incompatibility is required so as to ensure that the parties have
award of 10% attorney’s fees to be reasonable. indeed intended such novation despite their failure to express it in
Neither can the appellate court be held to have erred in rejecting categorical terms. The incompatibility, to be sure, should take place in any
petitioners’ call for a new trial or to admit newly-discovered evidence. As of the essential elements of the obligation, i.e., (1) the juridical relation or
the appellate court so held in its resolution of 14 May 1999— tie, such as from a mere commodatum to lease of things, or
“Under Section 2, Rule 52 of the 1997 Rules of Civil Procedure, no second from negotiorum gestio to agency, or from a mortgage to antichresis, 25 or
motion for reconsideration of a judgment or final resolution by the same from a sale to one of loan; 26 (2) the object or principal conditions, such as a
party shall be entertained. Considering that the instant motion is already a change of the nature of the prestation; or (3) the subjects, such as
second motion for reconsideration, the same must therefore be denied. _______________
“Furthermore, it would appear from the records available to this court
21
that the newly-discovered evidence being invoked by defendants-  Memorandum for Petitioners, Rollo, p. 196.
22
appellants have actually been existent when the case was brought on  Velasquez vs. Court of Appeals, 309 SCRA 539 (1999); Ong vs. Court
appeal to this court as well as when the first motion for reconsideration of Appeals, 310 SCRA 1 (1999); Bautista vs. Pilar Development
was filed. Hence, it is quite surprising why defendants-appellants raised Corporation, 312 SCRA 611 (1999).
23
the alleged newly-discovered evidence only at this stage when they could  See Article 1292, Civil Code; Pacific Mills, Inc. vs. Court of
have done so in the earlier pleadings filed before this court. Appeals, 206 SCRA 317 (1992); Quinto vs. People, 305 SCRA
“The propriety or acceptability of such a second motion for 708 (1999); Cruz vs. Court of Appeals, 293 SCRA 239 (1998).
24
reconsideration is not contingent upon the averment of ‘new’ grounds to  Magdalena Estates, Inc. vs. Rodriguez, 18 SCRA 967 (1966), as
assail the judgment, i.e., grounds other than those theretofore presented reiterated in Velasquez vs. Court of Appeals, 309 SCRA 539 (1999).
25
and rejected. Otherwise, attainment of finality of a judgment might be  Jagunap vs. Mirasol, [CA], 48 O.G. 3911.
26
stayed off indefinitely, depending on the party’s ingenuousness or  Soncuya vs. Azarraga, 65 Phil. 635.
cleverness in conceiving and formulating ‘additional flaws’ or ‘newly
discovered errors’ therein, or thinking up some injury or prejudice to the 572
rights of the movant for reconsideration.” 20 572 SUPREME COURT REPORTS ANNOTATED
At any rate, the subsequent execution of the real estate mortgage as Ligutan vs. Court of Appeals
security for the existing loan would not have resulted in the the substitution of a debtor 27 or the subrogation of the creditor. Extinctive
_______________ novation does not necessarily imply that the new agreement should be
complete by itself; certain terms and conditions may be carried, expressly
20
 Rollo, p. 53. or by implication, over to the new obligation.
WHEREFORE, the petition is DENIED.
571 SO ORDERED.
     Melo (Chairman), Panganiban, Sandoval-Gutierrez and Carpio,
VOL. 376, FEBRUARY 12, 2002 571
JJ., concur.
 Petition denied.
Notes.—There can be no novation unless two distinct and successive
binding contracts take place, with the later one designed to replace the
preceding convention. Modifications introduced before a bargain becomes
obligatory can in no sense constitute novation in law. (Montelibano vs.
Bacolod-Murcia Co., Inc., 5 SCRA 36 [1962])
Novation is never presumed—it must be proven as a fact either by
express stipulation of the parties or by implication derived from an
irreconcilable incompatibility between old and new obligations or
contracts. (Uraca vs. Court of Appeals, 278 SCRA 702 [1997])
There is no novation where the obligation to pay a sum of money
remained and the assignment merely served as security for the loans
covered by the promissory notes. (Development Bank of the Philippines vs.
Court of Appeals, 284 SCRA 14 [1998])

——o0o——

_______________

27
 Azarraga vs. Rodriquez, 9 Phil. 637.
 VOL. 221, APRIL 7, 1993
Social Security System vs. Moonwalk Development and Housing Corporation
G.R. No. 73345. April 7, 1993.*
SOCIAL SECURITY SYSTEM, petitioner, vs. MOONWALK DEVELOPMENT &
HOUSING CORPORATION, ROSITA U. ALBERTO, ROSITA U. ALBERTO, JMA
HOUSE, INC., MILAGROS SANCHEZ SANTIAGO, in her capacity as Register
of Deeds for the Province of Cavite, ARTURO SOLITO, in his capacity as
Register of Deeds for Metro Manila District IV, Makati, Metro Manila and the
INTERMEDIATE APPELLATE COURT, respondents.
Contracts; Penal Clause; Function.—A penal clause is an accessory
undertaking to assume greater liability in case of breach. It has a double
function: (1) to provide for liquidated damages, and (2) to strengthen the
coercive force of the obligation by the threat of greater responsibility in the
event of breach. From the foregoing, it is clear that a penal clause is
intended to prevent the obligor from defaulting in the
_______________
*
 SECOND DIVISION.
120
120 SUPREME COURT REPORTS ANNOTATED
Social Security System vs. Moonwalk Development and Housing Corporation
performance of his obligation. Thus, if there should be default, the
penalty may be enforced.
Obligations; Requisites in order that debtor may be in
default; Necessity of demand.—To be in default “x x x is different from
mere delay in the grammatical sense, because it involves the beginning of
a special condition or status which has its own peculiar effects or results.”
In order that the debtor may be in default it is necessary that the following
requisites be present: (1) that the obligation be demandable and already
liquidated; (2) that the debtor delays performance; and (3) that the
creditor requires the performance judicially and extrajudicially. Default
generally begins from the moment the creditor demands the performance
of the obligation. Nowhere in this case did it appear that SSS demanded
from Moonwalk the payment of its monthly amortizations. Neither did it
show that petitioner demanded the payment of the stipulated penalty upon
the failure of Moonwalk to meet its monthly amortization. What the
complaint itself showed was that SSS tried to enforce the obligation
sometime in September, 1977 by foreclosing the real estate mortgages
executed by Moonwalk in favor of SSS. But this foreclosure did not push
through upon Moonwalk’s requests and promises to pay in full. The next
demand for payment happened on October 1, 1979 when SSS issued a
Statement of Account to Moonwalk And in accordance with said statement,
Moonwalk paid its loan in full. What is clear, therefore, is that Moonwalk
was never in default because SSS never compelled performance.
119 PETITION for review on certiorari of the decision of the then Intermediate
Appellate Court.
The facts are stated in the opinion of the Court.
     The Solicitor General for petitioner.
     K.V. Faylona & Associates for private respondents.
CAMPOS, JR., J.:
Before Us is a petition for review on certiorari of a decision 1 of
_______________
1
 AC-G.R. CV No. 68692, “Social Security System vs. Moonwalk
Development & Housing Corporation, et al.”, penned by Associate Justice
Eduardo P. Caguioa, Associate Justices Abdulwahid A. Bidin and Floreliana
C. Bartolome, concurring with dissenting opinion of
121
VOL. 221, APRIL 7, 1993 121
Social Security System vs. Moonwalk Development and Housing Corporation
the then Intermediate Appellate Court affirming in toto the decision of the
former Court of First Instance of Rizal, Seventh Judicial District, Branch
XXIX, Pasay City.
The facts as found by the Appellate Court are as follows:
“On February 20, 1980, the Social Security System, SSS for brevity, filed a
complaint in the Court of First Instance of Rizal against Moonwalk
Development & Housing Corporation, Moonwalk for short, alleging that the
former had committed an error in failing to compute the 12% interest due
on delayed payments on the loan of Moonwalk—resulting in a chain of
errors in the application of payments made by Moonwalk and, in an unpaid
balance on the principal loan agreement in the amount of P7,053.77 and,
also in not reflecting in its statement of account an unpaid balance on the
said penalties for delayed payments in the amount of P7,517,178.21 as of
October 10, 1979.
Moonwalk answered denying SSS’ claims and asserting that SSS had
the opportunity to ascertain the truth but failed to do so.
The trial court set the case for pre-trial at which pre-trial conference,
the court issued an order giving both parties thirty (30) days within which
to submit a stipulation of facts.
The Order of October 6, 1980 dismissing the complaint followed the
submission by the parties on September 19, 1980 of the following
stipulation of Facts:
1. “1.On October 6, 1971, plaintiff approved the application of
defendant Moonwalk for an interim loan in the amount of THIRTY
MILLION PESOS (P30,000,000.00) for the purpose of developing
and constructing a housing project in the provinces of Rizal and
Cavite;
 2. “2.Out of the approved loan of THIRTY MILLION PESOS
(P30,000,000.00) the sum of P9,595,000.00 was released to
defendant Moonwalk as of November 28, 1973;
3. “3.A third Amended Deed of First Mortgage was executed on
December 18, 1973 Annex ‘D’ providing for restructuring of the
payment of the released amount of P9,595,000.00.
4. “4.Defendants Rosita U. Alberto and Rosita U. Alberto, mother and
daughter respectively, under paragraph 5 of the aforesaid Third
Amended Deed of First Mortgage substituted
_______________
Presiding Justice Ramon G. Gaviola, Jr. and Associate Justice Ma.
Rosario Quetulio-Losa, concurring.
122
122 SUPREME COURT REPORTS ANNOTATED
Social Security System vs. Moonwalk Development and Housing Corporation
1. Associated Construction and Surveys Corporation, Philippine Model
Homes Development Corporation, Mariano Z. Velarde and
Eusebio T. Ramos, as solidary obligors;
2. “5.On July 23, 1974, after considering additional releases in the
amount of P2,659,700.00, made to defendant Moonwalk,
defendant Moonwalk delivered to the plaintiff a promissory note
for TWELVE MILLION TWO HUNDRED FIFTY FOUR THOUSAND
SEVEN HUNDRED PESOS (P12,254,700.00) Annex ‘E’, signed by
Eusebio T. Ramos, and the said Rosita U. Alberto and Rosita U.
Alberto;
3. “6.Moonwalk made a total payment of P23,657,901.84 to SSS for
the loan principal of P12,254,700.00 released to it. The last
payment made by Moonwalk in the amount of P15,004,905.74
were based on the Statement of Account, Annex “F” prepared by
plaintiff SSS for defendant;
4. “7.After settlement of the account stated in Annex ‘F’ plaintiff
issued to defendant Moonwalk the Release of Mortgage for
Moonwalk’s mortgaged properties in Cavite and Rizal, Annexes
‘G’ and ‘H’ on October 9, 1979 and October 11, 1979
respectively.
5. “8.In letters to defendant Moonwalk, dated November 28, 1979
and followed up by another letter dated December 17, 1979,
plaintiff alleged that it committed an honest mistake in releasing
defendant.
6. “9.In a letter dated December 21, 1979, defendant’s counsel told
plaintiff that it had completely paid its obligations to SSS; “10.
The genuineness and due execution of the documents marked as
Annex (sic) ‘A’ to ‘O’ inclusive of the Complaint and the letter
dated December 21, 1979 of the defendant’s counsel to the
plaintiff are admitted.
7. “Manila for Pasay City, September 2, 1980.”2
On October 6, 1990, the trial court issued an order dismissing the
complaint on the ground that the obligation was already extinguished by
the payment by Moonwalk of its indebtedness to SSS and by the latter’s
act of cancelling the real estate mortgages executed in its favor by
defendant Moonwalk. The Motion for Reconsideration filed by SSS with the
trial court was likewise dismissed by the latter.
_______________
2
 Annex “A” of Petition, pp. 1-3; Rollo, pp. 44-46.
123
VOL. 221, APRIL 7, 1993 123
Social Security System vs. Moonwalk Development and Housing Corporation
These orders were appealed to the Intermediate Appellate Court.
Respondent Court reduced the errors assigned by the SSS into this issue:
“x x x are defendants-appellees, namely, Moonwalk Development and
Housing Corporation, Rosita U. Alberto, Rosita U. Alberto, JMA House, Inc.
still liable for the unpaid penalties as claimed by plaintiff-appellant or is
their obligation extinguished?”3 As We have stated earlier, the respondent
Court held that Moonwalk’s obligation was extinguished and affirmed the
trial court.
Hence, this Petition wherein SSS raises the following grounds for
review:
“First, in concluding that the penalties due from Moonwalk are “deemed
waived and/or barred,” the appellate court disregarded the basic tenet that
waiver of a right must be express, made in a clear and unequivocal
manner. There is no evidence in the case at bar to show that SSS made a
clear, positive waiver of the penalties, made with full knowledge of the
circumstances.
Second, it misconstrued the ruling that SSS funds are trust funds, and
SSS, being a mere trustee, cannot perform acts affecting the same,
including condonation of penalties, that would diminish property rights of
the owners and beneficiaries thereof. (United Christian Missionary Society
v. Social Security Commission, 30 SCRA 982, 988 [1969])
Third, it ignored the fact that penalty at the rate of 12% p.a. is not
inequitable.
Fourth, it ignored the principle that equity will cancel a release on the
ground of mistake of fact.”4
The same problem which confronted the respondent court is presented
before Us: Is the penalty demandable even after the extinguishment of the
principal obligation?
The former Intermediate Appellate Court, through Justice Eduardo P.
Caguioa, held in the negative. It reasoned, thus:
“2. As we have explained under No. 1, contrary to what the plaintiff-
appellant states in its Brief, what is sought to be recovered in
_______________
 3
 Decision, p. 13; Rollo, p. 56.
4
 Petition, p. 12; Rollo, p. 27.
124
124 SUPREME COURT REPORTS ANNOTATED
Social Security System vs. Moonwalk Development and Housing Corporation
this case is not the 12% interest on the loan but the 12% penalty for failure
to pay on time the amortization. What is sought to be enforced therefore is
the penal clause of the contract entered into between the parties.
Now, what is a penal clause. A penal clause has been defined as
“an accessory obligation which the parties attach to a principal obligation
for the purpose of insuring the performance thereof by imposing on the
debtor a special prestation (generally consisting in the payment of a sum
of money) in case the obligation is not fulfilled or is irregularly or
inadequately fulfilled” (3 Castan 8th Ed. p. 118)
Now an accessory obligation has been defined as that attached to a
principal obligation in order to complete the same or take its place in the
case of breach (4 Puig Peña Part 1 p. 76). Note therefore that an accessory
obligation is dependent for its existence on the existence of a principal
obligation. A principal obligation may exist without an accessory obligation
but an accessory obligation cannot exist without a principal obligation. For
example, the contract of mortgage is an accessory obligation to enforce
the performance of the main obligation of indebtedness. An indebtedness
can exist without the mortgage but a mortgage cannot exist without the
indebtedness, which is the principal obligation. In the present case, the
principal obligation is the loan between the parties. The accessory
obligation of a penal clause is to enforce the main obligation of payment of
the loan. If therefore the principal obligation does not exist the penalty
being accessory cannot exist.
Now then when is the penalty demandable? A penalty is demandable in
case of non performance or late performance of the main obligation. In
other words in order that the penalty may arise there must be a breach of
the obligation either by total or partial non fulfillment or there is non
fulfillment in point of time which is called mora or delay. The debtor
therefore violates the obligation in point of time if there is mora or delay.
Now, there is no mora or delay unless there is a demand. It is noteworthy
that in the present case during all the period when the principal obligation
was still subsisting, although there were late amortizations there was no
demand made by the creditor, plaintiff-appellant for the payment of the
penalty. Therefore up to the time of the letter of plaintiff-appellant there
was no demand for the payment of the penalty, hence the debtor was not
in mora in the payment of the penalty.
However, on October 1, 1979, plaintiff-appellant issued its statement of
account (Exhibit F) showing the total obligation of Moonwalk
125
VOL. 221, APRIL 7, 1993
Social Security System vs. Moonwalk Development and Housing Corporation
as P15,004,905.74, and forthwith demanded payment from defendant-
appellee. Because of the demand for payment, Moonwalk made several
payments on September 29, October 9 and 19, 1979 respectively, all in all
totalling P15,004,905.74 which was a complete payment of its obligation
as stated in Exhibit F. Because of this payment the obligation of Moonwalk
was considered extinguished, and pursuant to said extinguishment, the
real estate mortgages given by Moonwalk were released on October 9,
1979 and October 10, 1979 (Exhibits G and H). For all purposes therefore
the principal obligation of defendant-appellee was deemed extinguished as
well as the accessory obligation of real estate mortgage; and that is the
reason for the release of all the Real Estate Mortgages on October 9 and
10, 1979 respectively.
Now, besides the Real Estate Mortgages, the penal clause which is also
an accessory obligation must also be deemed extinguished considering
that the principal obligation was considered extinguished, and the penal
clause being an accessory obligation cannot exist without a principal
obligation. That being the case, the demand for payment of the penal
clause made by plaintiff-appellant in its demand letter dated November 28,
1979 and its follow up letter dated December 17, 1979 (which
parenthetically are the only demands for payment of the penalties) are
therefore ineffective as there was nothing to demand. It would be
otherwise, if the demand for the payment of the penalty was made prior to
the extinguishment of the obligation because then the obligation of
Moonwalk would consist of: 1) the principal obligation 2) the interest of
12% on the principal obligation and 3) the penalty of 12% for late payment
for after demand, Moonwalk would be in mora and therefore liable for the
penalty.
Let it be emphasized that at the time of the demand made in the letters
of November 28, 1979 and December 17, 1979 as far as the penalty is
concerned, the defendant-appellee was not in default since there was no
mora prior to the demand. That being the case, therefore, the demand
made after the extinguishment of the principal obligation which carried
with it the extinguishment of the penal clause being merely an accessory
obligation, was an exercise in futility. 3. At the time of the payment made
of the full obligation on
October 10, 1979 together with the 12% interest by defendant-appellee
Moonwalk, its obligation was extinguished. It being extinguished, there was
no more need for the penal clause. Now, it is to be noted that penalty at
anytime can be modified by the Court. Even substantial performance under
Art. 1234 authorizes the Court to consider it as complete performance
minus damages. Now, Art. 1229 Civil Code of the Philippines provides:
126
126 SUPREME COURT REPORTS ANNOTATED
Social Security System vs. Moonwalk Development and Housing Corporation
“ART. 1229. The judge shall equitably reduce the penalty when the
principal obligation has been partly or irregularly complied with by the
125 debtor. Even if there has been no performance, the penalty may also be
reduced by the courts if it is iniquitous or unconscionable.”
 If the penalty can be reduced after the principal obligation has been
partly or irregularly complied with by the debtor, which is nonetheless a
breach of the obligation, with more reason the penal clause is not
demandable when full obligation has been complied with since in that case
there is no breach of the obligation. In the present case, there has been as
yet no demand for payment of the penalty at the time of the
extinguishment of the obligation, hence there was likewise an
extinguishment of the penalty.
Let Us emphasize that the obligation of defendant-appellee was fully
complied with by the debtor, that is, the amount loaned together with the
12% interest has been fully paid by the appellee. That being so, there is no
basis for demanding the penal clause since the obligation has been
extinguished. Here there has been a waiver of the penal clause as it was
not demanded before the full obligation was fully paid and extinguished.
Again, emphasis must be made on the fact that plaintiff-appellant has not
lost anything under the contract since it got back in full the amount loan
(sic) as well as the interest thereof. The same thing would have happened
if the obligation was paid on time, for then the penal clause, under the
terms of the contract would not apply. Payment of the penalty does not
mean gain or loss of plaintiff-appellant since it is merely for the purpose of
enforcing the performance of the main obligation. Since the obligation has
been fully complied with and extinguished, the penal clause has lost its
raison d’ entre”5
We find no reason to depart from the appellate court’s decision. We,
however, advance the following reasons for the denial of this petition.
Article 1226 of the Civil Code provides:
“Art. 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.
_______________
5 1. delivered or the service is to be rendered was a controlling motive
 Rollo, pp. 62-66.
127
VOL. 221, APRIL 7, 1993 127
Social Security System vs. Moonwalk Development and Housing Corporation
The penalty may be enforced only when it is demandable in
accordance with the provisions of this Code.” (Italics Ours.)
A penal clause is an accessory undertaking to assume greater liability in
case of breach.6 It 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. 7 From the foregoing,
it is clear that a penal clause is intended to prevent the obligor from
defaulting in the performance of his obligation. Thus, if there should be
default, the penalty may be enforced. One commentator of the Civil Code
wrote:
“Now when is the penalty deemed demandable in accordance with the
provisions of the Civil Code? We must make a distinction between a
positive and a negative obligation. With regard to obligations which are
positive (to give and to do), the penalty is demandable when the debtor is
in mora; hence, the necessity of demand by the debtor unless the same is
excused. x x x”8
When does delay arise? Under the Civil Code, delay begins from the time
the obligee judicially or extrajudicially demands from the obligor the
performance of the obligation.
“Art. 1169. Those obliged to deliver or to do something incur in delay from
the time the obligee judicially or extrajudicially demands from them the
fulfillment of their obligation.”
There are only three instances when demand is not necessary to render
the obligor in default. These are the following:
1. “(1)When the obligation or the law expressly so declares;
2. (2)When from the nature and the circumstances of the obligation it
appears that the designation of the time when the thing is to be
_______________
6
 4 TOLENTINO, CIVIL CODE OF THE PHILIPPINES 259 (1991 ed.).
7
 Ibid.
8
 4 E.P. CAGUIOA, COMMENTS AND CASES ON CIVIL LAW 280 (1983
ed.).
128
128 SUPREME COURT REPORTS ANNOTATED
Social Security System vs. Moonwalk Development and Housing Corporation
for the establishment of the contract; or
2. (3)When the demand would be useless, as when the obligor has
rendered it beyond his power to perform.”9
This case does not fall within any of the established exceptions. Hence,
despite the provision in the promissory note that “(a)ll amortization
payments shall be made every first five (5) days of the calendar month
until the principal and interest on the loan or any portion thereof actually
released has been fully paid,”10 petitioner is not excused from making a
demand. It has been established that at the time of payment of the full
obligation, private respondent Moonwalk has long been delinquent in
meeting its monthly arrears and in paying the full amount of the loan itself
as the obligation matured sometime in January, 1977. But mere
delinquency in payment does not necessarily mean delay in the legal
concept. To be in default “x x x is different from mere delay in the
grammatical sense, because it involves the beginning of a special
condition or status which has its own peculiar effects or results.” 11 In order
that the debtor may be in default it is necessary that the following
requisites be present: (1) that the obligation be demandable and already
liquidated; (2) that the debtor delays performance; and (3) that the
creditor requires the performance judicially and extrajudicially. 12 Default
generally begins from the moment the creditor demands the performance
of the obligation.13
Nowhere in this case did it appear that SSS demanded from Moonwalk
the payment of its monthly amortizations. Neither did it show that
petitioner demanded the payment of the stipulated penalty upon the
failure of Moonwalk to meet its monthly amortization. What the complaint
itself showed was that SSS tried to enforce the obligation sometime in
September, 1977 by foreclosing the real estate mortgages executed by
Moonwalk in favor of
_______________
9
 CIVIL CODE, Art. 1169.
10
 Annex “C” of the Petition, Record on Appeal, p. 10.
11
 Supra, note 6.
12
 Ibid.
13
 Ibid.
129
VOL. 221, APRIL 7, 1993 129
Social Security System vs. Moonwalk Development and Housing Corporation
SSS. But this foreclosure did not push through upon Moonwalk’s requests
and promises to pay in full. The next demand for payment happened on
October 1, 1979 when SSS issued a Statement of Account to Moonwalk.
And in accordance with said statement, Moonwalk paid its loan in full. What
is clear, therefore, is that Moonwalk was never in default because SSS
never compelled performance. Though it tried to foreclose the mortgages,
SSS itself desisted from doing so upon the entreaties of Moonwalk. If the
Statement of Account could properly be considered as demand for
payment, the demand was complied with on time. Hence, no delay
occurred and there was, therefore, no occasion when the penalty became
demandable and enforceable. Since there was no default in the
performance of the main obligation—payment of the loan—SSS was never
entitled to recover any penalty, not at the time it made the Statement of
Account and certainly, not after the extinguishment of the principal
obligation because then, all the more that SSS had no reason to ask for the
penalties. Thus, there could never be any occasion for waiver or even
mistake in the application for payment because there was nothing for SSS
to waive as its right to enforce the penalty did not arise.
SSS, however, in buttressing its claim that it never waived the
penalties, argued that the funds it held were trust funds and as trustee, the
petitioner could not perform acts affecting the funds that would diminish
property rights of the owners and beneficiaries thereof. To support its
claim, SSS cited the case of United Christian Missionary Society v. Social
Security Commission.14
We looked into the case and found out that it is not applicable to the
present case as it dealt not with the right of the SSS to collect penalties
which were provided for in contracts which it entered into but with its right
to collect premiums and its duty to collect the penalty for delayed payment
or non-payment of premiums. The Supreme Court, in that case, stated:
“No discretion or alternative is granted respondent Commission in the
enforcement of the law’s mandate that the employer who fails to
_______________
14
 30 SCRA 982, 987 (1969).
130
130 SUPREME COURT REPORTS ANNOTATED
Social Security System vs. Moonwalk Development and Housing Corporation
comply with his legal obligation to remit the premiums to the System
within the prescribed period shall pay a penalty of three (3%) per month.
The prescribed penalty is evidently of a punitive character, provided by the
legislature to assure that employers do not take lightly the State’s exercise
of the police power in the implementation of the Republic’s declared policy
“to develop, establish gradually and perfect a social security system which
shall be suitable to the needs of the people throughout the Philippines and
(to) provide protection to employers against the hazards of disability,
sickness, old age and death. x x x.”
Thus, We agree with the decision of the respondent Court on the matter
which We quote, to wit:
“Note that the above case refers to the condonation of the penalty for the
non remittance of the premium which is provided for by Section 22(a) of
the Social Security Act x x x. In other words, what was sought to be
condoned was the penalty provided for by law for non remittance of
premium for coverage under the Social Security Act.
The case at bar does not refer to any penalty provided for by law nor
does it refer to the non remittance of premium. The case at bar refers to a
contract of loan entered into between plaintiff and defendant Moonwalk
Development and Housing Corporation. Note, therefore, that no provision
of law is involved in this case, nor is there any penalty imposed by law nor
a case about non-remittance of premium required by law. The present case
refers to a contract of loan payable in installments not provided for by law
but by agreement of the parties. Therefore, the ratio decidendi of the case
of United Christian Missionary Society vs. Social Security Commission
which plaintiff-appellant relies is not applicable in this case; clearly, the
Social Security Commission, which is a creature of the Social Security Act
cannot condone a mandatory provision of law providing for the payment of
premiums and for penalties for non remittance. The life of the Social
Security Act is in the premiums because these are the funds from which
the Social Security Act gets the money for its purposes and the non-
remittance of the premiums is penalized not by the Social Security
Commission but by law.
xxxxxx
 It is admitted that when a government created corporation enters into
a contract with private party concerning a loan, it descends to the level of
a private person. Hence, the rules on contract applicable to private parties
are applicable to it. The argument therefore that the

131
VOL. 221, APRIL 7, 1993 131
Social Security System vs. Moonwalk Development and Housing Corporation
Social Security Commission cannot waive or condone the penalties which
was applied in the United Christian Missionary Society cannot apply in this
case. First, because what was not paid were installments on a loan but
premiums required by law to be paid by the parties covered by the Social
Security Act. Secondly, what is sought to be condoned or waived are
penalties not imposed by law for failure to remit premiums required by
law, but a penalty for non payment provided for by the agreement of the
parties in the contract between them. x x x”15

WHEREFORE, in view of the foregoing, the petition is DISMISSED and the

decision of the respondent court is AFFIRMED.
SO ORDERED.
     Narvasa (C.J., Chairman), Padilla, Regalado and Nocon, JJ., concur.

Petition dismissed. Decision affirmed.

Note.—Default generally begins from the moment the creditor
demands the performance of an obligation, without such demand, the
effect of default will not arise (Rose Packing Co., Inc. vs. Court of
Appeals, 167 SCRA 309).

——o0o——

_______________

15
 Supra, note 3, pp. 17-18.

132
© Copyright 2020 Central Book Supply, Inc. All rights reserved.
 G.R. No. 190512. June 20, 2018. *
 
D.M. RAGASA ENTERPRISES, INC., petitioner, vs. BANCO DE ORO, INC.
(formerly Equitable PCI Bank, Inc.), respondent.
Civil Law; Obligations; Obligations arising from contracts have the
force of law between the contracting parties and should be complied with
in good faith.—At the outset, it is well to remember that a contract is the
law between the parties. Obligations arising from contracts have the force
of law between the contracting parties and should be complied with in
good faith. The parties are allowed by law to enter into stipulations,
clauses, terms and conditions they may deem convenient which bind the
parties as long as they are not contrary to law, morals, good customs,
public order or public policy.
Same; Lease; Rescission; Termination of Lease; Damages; Generally,
if the lessor or lessee should not comply with their obligations, the
aggrieved party may ask for either the rescission of the contract and
indemnification for damages, or only the latter, allowing the contract to
remain in force.—Article 1170 of the Civil Code mandates that those who,
in the performance of their obligations, are guilty of fraud, negligence, or
delay, and those who, in any manner, contravene the tenor thereof, are
liable for damages. Thus, having contravened the tenor of the Lease
Contract regarding its term or period, the bank should be liable for
damages. However, how much in damages should the bank be liable?
Generally, if the lessor or the lessee should not comply with their
obligations, the aggrieved party may ask for either the rescission of the
contract and indemnification for damages, or only the latter, allowing the
contract to remain in force.
Same; Same; Same; Same; Same; To force either party to continue
with a contract that is automatically terminated in case of its breach by
either party (pursuant to its express provision) is not in furtherance of or
sanctioned by the contract.—Pursuant to the automatic termination clause
of the Lease Contract, which is in further-
_______________
*  SECOND DIVISION.
 
72
72 SUPREME COURT REPORTS ANNOTATED
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
ance of the autonomy characteristic of contracts, the Lease Contract
was terminated upon its unauthorized pre-termination by the bank on June
30, 2001. Ragasa is, thus, precluded from availing of the second option
which is to claim damages by reason of the breach and allow the lease to
remain in force. With the lease having been automatically resolved or
terminated by agreement of the parties, Ragasa is entitled only to
indemnification for damages. To force either party to continue with a
contract that is automatically terminated in case of its breach by either
party (pursuant to its express provision) is not in furtherance of or
sanctioned by the contract. Rather, it is a contravention thereof and it
negates the autonomy characteristic of contracts.
Same; Same; Same; Same; Rentals; Damages; Entitlement to rentals
after the termination of the lease pursuant to an automatic rescission or
termination clause is possible in the case where the lessor invokes the
clause and the lessee refuses to vacate the leased premises. The lessee
will be liable for damages equivalent to the rentals for the duration of its
possession from the termination of the lease until he vacates the
premises.—Entitlement to rentals after the termination of the lease
pursuant to an automatic rescission or termination clause is possible in the
case where the lessor invokes the clause and the lessee refuses to vacate
the leased premises. The lessee will be liable for damages equivalent to
the rentals for the duration of its possession from the termination of the
lease until he vacates the premises. This was in effect the ruling of the
Court in Manila Bay Club Corp. when it affirmed the award of the monthly
rental equivalent to P250,000.00, which was the valuation of the trial court
as affirmed by the CA.
Same; Obligations; Penal Clauses; A penal clause is an accessory
obligation which the parties attach to a principal obligation for the purpose
of insuring the performance thereof by imposing on the debtor a special
prestation (generally consisting in the payment of a sum of money) in case
the obligation is not fulfilled or is irregularly or inadequately fulfilled.—A
penal clause is an accessory obligation which the parties attach to a
principal obligation for the purpose of insuring the performance thereof by
imposing on the debtor a special prestation (generally consisting in the
payment of a sum of money) in case the obligation is not fulfilled or is
irregularly or inadequately fulfilled. Quite common in lease contracts, this
clause functions to
 
73
VOL. 867, JUNE 20, 2018 73
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
strengthen the coercive force of the obligation and to provide, in
effect, for what would be the liquidated damages resulting from a breach.
A penal clause has a three-fold purpose: (1) a coercive purpose or one of
guarantee — this is to urge the debtor to the fulfillment of the main
obligation under pain of paying the penalty; (2) to serve as liquidated
damages — this is to evaluate in advance the damages that may be
occasioned by the noncompliance of the obligation; and (3) a strictly penal
purpose — this is to punish the debtor for nonfulfillment of the main
obligation. While the first purpose is always present, the second purpose is
presumed and the third purpose must be expressly agreed upon.
Same; Same; Same; The penal clause may be considered either a
reparation, compensation or substitute for damages, on one hand, or as a
punishment in case of breach of the obligation, on the other.—Evidently,
the penal clause may be considered either reparation, compensation or
substitute for damages, on one hand, or as a punishment in case of breach
of the obligation, on the other. When considered as reparation or
compensation, the question as to the appropriate amount of damages is
resolved once and for all because the stipulated indemnity represents a
legitimate estimate made by the contracting parties of the damages
caused by the nonfulfillment or breach of the obligation. Proof of actual
damages is, consequently, not necessary in order that the stipulated
penalty may be demanded. When considered as a punishment, the
question of damages is not yet resolved inasmuch as the right to damages,
besides the penalty, still subsists. Thus, if the injured party desires to
recover the damages actually suffered by him in addition to the penalty, he
must prove such damages.
Same; Damages; Liquidated Damages; Liquidated damages are those
agreed upon by the parties to a contract, to be paid in case of breach
thereof.—Penal clause may be classified into: (1) according to source: (a)
legal (when it is provided by law) and (b) conventional (when it is provided
for by stipulation of the parties); (2) according to demandability: (a)
subsidiary (when only the penalty may be enforced) and (b)
complementary (when both the principal obligation and the penalty may
be enforced); and (3) according to purpose: (a) cumulative (when damages
may be collected in addition to penalty) and (b) reparatory (when the
penalty substitutes indemnity for
 
 
74
74 SUPREME COURT REPORTS ANNOTATED
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
damages). Item 8(m) of the Lease Contract is an accessory obligation
or prestation to the principal obligation of lease. It specifies the stipulated
amount of liquidated damages — the full deposit — to be awarded to the
injured party in case of breach of the Term or period of the principal
obligation. Hence, as to source, it is conventional. As defined, liquidated
damages are those agreed upon by the parties to a contract, to be paid in
case of breach thereof. The amount of the liquidated damages is purely
contractual between the parties; and the courts will intervene only to
equitably reduce the liquidated damages, whether intended as an
indemnity or a penalty, if they are iniquitous or unconscionable, pursuant
to Articles 2227 and 1229 of the Civil Code.
Same; Same; Actual Damages; Penal Clauses; Proof of actual
damages suffered by the creditor is not necessary in order that the penalty
may be demanded.—Proof of actual damages suffered by the creditor is
not necessary in order that the penalty may be demanded. Item 8(m)
seeks to insure or guarantee the completion of the lease period since its
noncompliance shall be met with a penalty. The degree of the coercive
effect or impact of the penalty to insure or guarantee the performance of
the principal obligation depends largely on the stipulated amount of the
liquidated damages. If the amount is substantial, then the compulsion to
perform may be greater. The obligor may not, however, be willing to
accept a very stiff penalty. As expressed earlier, the amount is purely
discretionary on the parties provided that it will pass the test of
unconscionability or excessiveness. Since the herein parties have agreed
on a specific amount of penalty, P367,821.00 or the full deposit, the Court
will not even second guess whether it is substantial enough to insure the
compliance of the lease period. The Court will simply rule that it is
reasonable.
Same; Penal Clauses; From the first paragraph of Article 1226, it is
evident that, as a rule, the penalty is fixed by the contracting parties as a
compensation or substitute for damages in case of breach of the
obligation; and it is, therefore, clear that the penalty in its compensatory
aspect is the general rule, while the penalty in its strictly penal aspect is
the exception.—From the first paragraph of Article 1226, it is evident that,
as a rule, the penalty is fixed by the contracting parties as a compensation
or substitute for damages in
 
 
75
VOL. 867, JUNE 20, 2018 75
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
case of breach of the obligation; and it is, therefore, clear that the
penalty in its compensatory aspect is the general rule, while the penalty in
its strictly penal aspect is the exception.
Same; Same; Obligations; Contracts; It is clear from paragraph 1 of
Article 1226 that when an obligation or a contract contains a penal clause,
the penalty shall substitute the indemnity for damages and the payment of
interests in case of noncompliance with or breach of the principal
obligation.—It is also clear from paragraph 1 of Article 1226 that when an
obligation or a contract contains a penal clause, the penalty shall
substitute the indemnity for damages and the payment of interests in case
of noncompliance with or breach of the principal obligation. This general
rule, however, admits three exceptions, namely: (1) when there is a
stipulation to the contrary; (2) when the obligor or debtor is sued for
refusal to pay the agreed penalty; and (3) when the obligor or debtor is
guilty of fraud. In these exceptions, it is evident that the purpose of the
penalty is to punish since the obligee or creditor can recover from the
obligor or debtor not only the penalty, but also the damages or interests
resulting from the breach of the principal obligation.
Same; Same; The requisites for the demandability of the penal clause
are present in this case. These are: (1) that the total nonfulfillment of the
obligation or the defective fulfillment is chargeable to the fault of the
debtor; and (2) that the penalty may be enforced in accordance with the
provisions of law.—Clearly, the requisites for the demandability of the
penal clause are present in this case. These are: (1) that the total
nonfulfillment of the obligation or the defective fulfillment is chargeable to
the fault of the debtor; and (2) that the penalty may be enforced in
accordance with the provisions of law. As to the second requisite, the
penalty is demandable when the debtor is in mora in regard to obligations
that are positive (to give and to do) where demand may be necessary
unless it is excused; and with regard to negative obligations, when an act
is done contrary to that which is prohibited.
Same; Diligence of Good Father of the Family; Article 2203 of the
Civil Code provides that “[t]he party suffering loss or injury must exercise
the diligence of a good father of a family to minimize the damages
resulting from the act or omission.”—Article 2203 of the Civil
76
76 SUPREME COURT REPORTS ANNOTATED
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
Code provides that ‘‘[t]he party suffering loss or injury must exercise
the diligence of a good father of a family to minimize the damages
resulting from the act or omission.’’ Ragasa likewise failed in this respect.
PETITION for review on certiorari of the decision and resolution of the Court
of Appeals Special Thirteenth Division and Former Special Thirteenth
Division.
The facts are stated in the opinion of the Court.
   Tomas Carmelo T. Araneta for petitioner.
 BDO Unibank, Inc. Legal Services Group for respondent.
 
CAGUIOA, J.:
 
Before the Court is a Petition for Review1 on Certiorari (Petition) under
Rule 45 of the Rules of Court (Rules) filed by petitioner D.M. Ragasa
Enterprises, Inc., (Ragasa) against respondent Banco de Oro,
Inc.,2 formerly Equitable PCI Bank, Inc. (bank), assailing the Decision 3 dated
March 27, 2009 (questioned Decision) and Resolution4 dated November 25,
2009, both of the Court of Appeals (CA) Special Thirteenth (13th) Division
and Former Special Thirteenth Division, respectively, in C.A.-G.R. CV No.
88322.
The CA reversed and set aside the rulings in favor of Ragasa of the
Regional Trial Court (RTC) of Quezon City,  9   Id., at p. 93.
_______________
1  Rollo, pp. 12-30.
2  Banco de Oro, Inc., is the surviving corporation upon the merger of
Equitable PCI Bank, Inc. and Banco de Oro, Inc., per the Comment of
respondent bank, id., pp. 236-253.
3  Id., at pp. 33-51. Penned by Associate Justice Pampio A. Abarintos,
with Associate Justices Amelita G. Tolentino and Ramon R. Garcia,
concurring.
4  Id., at pp. 60-62.
 
 
77
VOL. 867, JUNE 20, 2018 77
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
Branch 216, in its Decision dated April 4, 2006 5 and Order dated October 3,
20066 (denying the corresponding Motion for Reconsideration) in Civil Case
No. Q-02-46341.
The Facts
On January 30, 1998, Ragasa and then Equitable Banking Corporation
(Equitable Bank) executed a Contract of Lease7 (Lease Contract), as lessor
and lessee, respectively, over the ground and second floors of a
commercial building located at 175 Tomas Morato Avenue corner Scout
Castor, Quezon City (subject premises), for a period of five years,
commencing on February 1, 1998 8 up to January 31, 2003 9, with a monthly
rental of P122,607.00.10 The pertinent provisions of the Lease Contract
state, viz.:
x x x x
2.  The TERM of this Lease shall be for a period of five (5) years,
commencing on February 1, 1998. x x x
3.  The TENANT shall pay a monthly rental of ONE HUNDRED
TWENTY-TWO THOUSAND SIX HUNDRED SEVEN (P122,607) pesos
based on P463.16 per square meter per month inclusive of Value
Added Tax and withholding tax and payable in advance in the first
five days of the month, that is 1st to 5th of every month. An annual
increase of 10% shall be applied during the term of the lease.
4.  The failure to pay two consecutive monthly rentals within
the first five (5) days of any month, as 
_______________
5   Id., at pp. 140-153. Penned by Judge Ofelia Arellano Marquez.
6   Id., at p. 154.
7   Id., at pp. 63-67.
8   Id., at p. 63.
10  Id., at p. 64
 
78
78 SUPREME COURT REPORTS ANNOTATED
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
stated in No. 3, shall automatically terminate this Contract, without
need of any further notice to the TENANT. The LESSOR is hereby
 authorized, and has the right to show the premises to prospective
tenants, and within five (5) days following the last day of the grace
period stated in No. 3, the TENANT shall vacate the premises
without the need of the usual judicial proceedings, and/or the
LESSOR shall padlock the premises until the TENANT settles his
obligations. The TENANT agrees to this padlocking as a sign of his
good faith in his compliance with No. 3 of this Contract and the
LESSOR is not liable or answerable for any damage that the TENANT
may incur or suffer due to his non-entrance to the premises, or the
LESSOR may confiscate any property found in the premises
equivalent to the unpaid rental, penalty, and interests thereto, as
guaranty and/or pledge, and can be retrieved anytime upon full
payment of his accounts but must not be for more than three (3)
months from the date of default [;] otherwise, the confiscated
property or properties shall become permanently owned by the
LESSOR as partial payment of his unpaid rentals, penalties and
interests, and in case of any unpaid balance, the TENANT is still
liable.
 x x x x
7. The parties hereby covenant and agree upon the signing of
this Contract of Lease that [the] TENANT shall pay to the LESSOR or
his representative, the amount of SEVEN HUNDRED THIRTY-FIVE
THOUSAND SIX HUNDRED FORTY-TWO (P735,642) pesos, Philippine
Currency, P367,821 as three months advanced rental, and P367,821
as three months deposit, which deposit shall be refunded to the
TENANT only upon termination of this Lease, that is, after expiration
of the lease, paid occupancy of the said premises, and after
vacating the same and also after deducting the unpaid water bills[,]
if any, electric bills, extraordinary wear and tear of the premises,
losses and breakages of the premises, and other damages sustained
by the LESSOR.
 
 
79
VOL. 867, JUNE 20, 2018
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
8. The TENANT voluntarily binds himself and agrees to the
following without any coercion or force by the LESSOR;
 x x x x
m) The full deposit shall be forfeited in favor of the LESSOR
upon noncompliance of the Term of the Contract of Lease by the
TENANT, and cannot be applied to Rental;
n) To pay a penalty of 3% of the monthly rental, for every
month of delay of payment of the monthly rental, [with] a fraction of
the month x x x considered [as] one month;
p) Breach or noncompliance of any of the provisions of this
Contract, especially nonpayment of two consecutive monthly rentals
on time, shall mean the termination of this Contract, and within five
(5) days from the date of breach, noncompliance, or default, the
TENANT shall vacate the premises quietly and peacefully without
need of the required judicial proceedings. If he does not vacate the
premises, the TENANT has agreed that the LESSOR has no liability
whatsoever due to the padlocking of the same;
 x x x x
10. In the event that a Court Litigation has been resorted to by
the LESSOR or LESSEE, due to noncompliance of any of the
foregoing provisions, the aggrieved party shall be paid by the other
party, no less than fifteen thousand (P15,000) pesos, Philippine
Currency, for Attorney’s fees, and other damages that the honorable
court may allow; the cost of litigations shall be born[e] or paid by
the party in fault, or in default.All unpaid accounts and obligations of
the TENANT shall earn interest or bear interest at the rate of
14% per annum or at the allowable rate of interest from the date of
default.
 
 
80
80 SUPREME COURT REPORTS ANNOTATED
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
The legal suits shall be brought in the town of Quezon City. 11
Pursuant to the Lease Contract, Equitable Bank paid the amounts of
P367,821.00 representing three months advance rentals, and P367,821.00
representing three months rentals as security deposit. 12
Meanwhile, Equitable Bank entered into a merger with Philippine
Commercial International Bank (PCI Bank) thereby forming Equitable PCI
Bank, Inc.13 The latter would eventually, pending the present case, merge
with Banco de Oro, Inc. to form the respondent bank.14
As a result of the merger, the bank closed and joined the branches of
its constituent banks which were in close proximity with each other as
79 maintaining said branches would be impractical. 15 One of the branches
which had to be closed is the branch located in the subject premises. 16
For this reason, the bank sent a notice dated May 28, 2001, informing
Ragasa that the former was pre-terminating their Lease Contract effective
June 30, 2001 (Notice of Pre-termination).17 Ragasa responded with a
demand letter dated June 20, 200118 for payment of monthly rentals for the
remaining term of the Lease Contract from July 1, 2001 to January 31, 2003
totaling P3,146,596.42, inasmuch as there is no express provision in the
Lease Contract allowing pre-
_______________
11  Id., at pp. 63-66.
12  Id., at p. 39.
13  Id.
14  Id., at p. 236.
15  Id., at p. 237.
 16  Id., at p. 39.
17  Id., at p. 92.
18  Id., at p. 93.
 
 
81
VOL. 867, JUNE 20, 2018
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
termination.19 The bank countered, through a letter dated June 26,
2001,20 that its only liability for pre-terminating the contract is the
forfeiture of its security deposit pursuant to item 8(m) of the Lease
Contract.21 On June 30, 2001, the bank vacated the subject premises
without heeding Ragasa’s demand for payment.
After sending two more reiterative demand letters, 22 which were both
ignored by the bank, Ragasa finally filed on March 11, 2002 with the RTC
the Complaint for Collection of Sum of Money (amounting to P3,146,596.42
representing the monthly rentals under the Lease Contract for the period
July 1, 2001 to January 31, 2003) and Damages. Ragasa argued that under
the Lease Contract, the forfeiture of the bank’s security deposit does not
exempt it from payment of the rentals for the remaining term of the lease
because the bank’s act of pre-terminating the contract was a major breach
of its terms. Moreover, item 8(m) expressly provides that the security
deposit shall not be applied to the rentals.
In its Answer filed on April 26, 2002, the bank argued, in gist, that item
8(m) of the Lease Contract is actually a penalty clause which, in line with
Article 122623 of the Civil Code, takes the place of damages and interests
in case of breach. Hence, for breaching the Lease Contract by pre-
terminating
_______________
19  Id.
20  Id., at p. 134.
21  Id.
22  One dated July 27, 2001 and another dated February 27, 2002, id.,
at p. 40.
23  Art. 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. (1152a)
 
 
82
82 SUPREME COURT REPORTS ANNOTATED
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
the same, the bank is liable to forfeit its security deposit in favor of Ragasa
but would not be liable for rentals corresponding to the remaining life of
the Contract. Moreover, the bank is not liable for the penalty at the rate of
3% under item 8(n) of the Lease Contract because the bank paid the due
81 rentals up to the time it pre-terminated the same.24
Ruling of the RTC
 
The RTC ruled in Ragasa’s favor in a Decision dated April 4, 2006, the
dispositive portion of which reads:
 
WHEREFORE, the Court finds that plaintiff has established its
case against defendant by preponderance of evidence and judgment
is hereby rendered ordering defendant Equitable PCI Bank, Inc. to
pay plaintiff the following:
1. The amount of P3,146,596.42 Philippine Currency,
representing the monthly rentals from July 1, 2001 to January
31, 2003;
2. A penalty of 3% of the monthly rental for every month of
delay;
3. An interest of 14% per annum on the full amount due until
fully paid;
4. Attorney’s fees in the amount of P30,000.00; and
5. Costs of litigation.
Defendant’s Counterclaim is dismissed.
SO ORDERED.25
 
The RTC held that the bank may not unilaterally pre-terminate the
Lease Contract; hence, it is still liable to pay
_______________
24  Id., at p. 98.
25  Id., at p. 153.
 
 
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the rentals for the remaining duration of the said contract. Likewise, in
addition to item 8(m) of the Lease Contract providing for the forfeiture of
the bank’s security deposit, item 8(n), another penalty clause providing for
additional 3% of the monthly rental for each month of delay in payment,
also applies. Finally, pursuant to Section 10, an interest of 14% per
annum on the amount due was awarded.
 The bank filed a Motion for Reconsideration which was denied by the
RTC in its Order dated October 3, 2006. 26
On October 23, 2006, the bank filed a Notice of Appeal to the CA,
arguing that the Lease Contract was automatically terminated by the act of
the bank in pre-terminating the lease or based on the provisions of the
Lease Contract, and that upon termination of the lease, the bank has been
released from its future contractual obligations including the payment of
‘‘future rentals.’’27
 
Ruling of the CA
 
In the questioned Decision dated March 27, 2009, the CA granted the
bank’s appeal and reversed and set aside the RTC’s ruling, disposing of the
case as follows:
WHEREFORE, the appeal is hereby GRANTED. The ruling of the
trial court is hereby REVERSED and SET ASIDE. The complaint is
dismissed for lack of legal basis.
SO ORDERED.28
The CA ruled that the bank’s failure to continue the Lease Contract until
its expiration constituted a breach of its provi-
_______________
26  Id., at p. 154.
27  Brief for the Defendant-Appellant dated June 20, 2007, id., at pp.
164-166.
28  Id., at p. 50.
 
 
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sion. As such, the Lease Contract was automatically terminated by virtue
of item 8(p) thereof providing for its outright termination in case of breach
of any of its provisions. Hence, there is no legal basis to hold the bank
liable for payment of rentals for the unexpired period of the contract.
However, the bank is liable to forfeit its security deposit pursuant to the
penalty clause under item 8(m) of the contract. The CA ruled that to allow
Ragasa to collect the value of the unexpired term of the lease plus penalty
would constitute unjust enrichment.
Ragasa filed a Motion for Reconsideration of the questioned Decision,
which the CA denied for lack of merit, in its Resolution dated November 25,
2009.29
Refusing to concede, Ragasa filed the present Petition on January 21,
2010 raising four main issues, namely:
 
Issues
1.) WHETHER OR NOT THE COURT OF APPEALS SERIOUSLY ERRED
IN LAW IN GRANTING THE APPEAL OF RESPONDENT BANK AND IN
DENYING THE MOTION FOR RECONSIDERATION OF THE PETITIONER
WHICH IS CONTRARY TO ARTICLES 1170 AND 1308 OF THE NEW
CIVIL CODE[.]
2.) WHETHER OR NOT THE COURT OF APPEALS SERIOUSLY ERRED
IN LAW IN RULING THAT THE PENALTY CLAUSE APPLICABLE IN THE
CASE IS ITEM NO. 8(m) OF THE CONTRACT, AND NOT ITEM 8(n) OF
THE SAME CONTRACT[.]
3.) WHETHER OR NOT THE COURT OF APPEALS SERIOUSLY ERRED
IN LAW IN RULING THAT THE SUBJECT CONTRACT HAD BEEN
TERMINATED[.]
4.) WHETHER OR NOT THE COURT OF APPEALS SERIOUSLY ERRED
IN LAW IN RULING THAT THE 
_______________
29  Id., at pp. 60-62.
 
 
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PETITIONER IS GUILTY OF UNJUST ENRICHMENT[.] 30
The fundamental issue that the Court is called upon to resolve is: What
is the liability of the bank, if any, for its act of pre-terminating the Lease
Contract?
At the outset, it is well to remember that a contract is the law between
the parties.31 Obligations arising from contracts have the force of law
between the contracting parties and should be complied with in good
faith.32 The parties are allowed by law 33 to enter into stipulations, clauses,
terms and conditions they may deem convenient which bind the parties as
long as they are not contrary to law, morals, good customs, public order or
public policy.34
The pertinent provisions of the Lease Contract are as follows:
2. The TERM of this Lease shall be for a period of five (5) years,
commencing on February 1, 1998. x x x
x x x x
7. The parties hereby covenant and agree upon the signing of
this Contract of Lease that [the] TENANT shall pay to the LESSOR or
his representative, the amount of SEVEN HUNDRED THIRTY-FIVE
THOUSAND SIX HUNDRED FORTY-TWO (P735,642) pesos, Philippine
Currency, P367,821 as three months advanced rental, and P367,821
as three months deposit, which deposit shall be refunded to the
TENANT only upon termination of this Lease, that is, after expiration
of the lease,
_______________
30  Id., at pp. 20-21.
31  Morla v. Belmonte, 678 Phil. 102, 107; 661 SCRA 717, 730 (2011).
32  CIVIL CODE, Art. 1159.
33  Id., at p. 1306.
34  Id.
 
 
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paid occupancy of the said premises, and after vacating the same
and also after deducting the unpaid water bills[,] if any, electric bills,
extraordinary wear and tear of the premises, losses and breakages
of the premises, and other damages sustained by the LESSOR.
8. The TENANT voluntarily binds himself and agrees to the
following without any coercion or force by the LESSOR;
x x x x
m) The full deposit shall be forfeited in favor of the LESSOR
upon noncompliance of the Term of the Contract of Lease by the
TENANT, and cannot be applied to Rental;
x x x x
p) Breach or noncompliance of any of the provisions of this
Contract, especially nonpayment of two consecutive monthly rentals
on time, shall mean the termination of this Contract, and within five
(5) days from the date of breach, noncompliance, or default, the
TENANT shall vacate the premises quietly and peacefully without
need of the required judicial proceedings. If he does not vacate the
premises, the TENANT has agreed that the LESSOR has no liability
whatsoever due to the padlocking of the same;
x x x x
10. In the event that a Court Litigation has been resorted to by
the LESSOR or LESSEE, due to noncompliance of any of the
foregoing provisions, the aggrieved party shall be paid by the other
party, no less than fifteen thousand (P15,000) pesos, Philippine
Currency, for Attorney’s fees, and other damages that the honorable
court may allow; the cost of litigations shall be born[e] or paid by
the party in fault, or in default. All unpaid accounts and obligations
of the TENANT shall earn interest or bear interest at the rate of
14% per annum or at
 
 
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the allowable rate of interest from the date of default. The legal
suits shall be brought in the town of Quezon City. 35 (Underscoring
supplied)
The foregoing stipulations are clear and show no contravention of law,
morals, good customs, public order or public policy. As such, they are valid,
and the parties’ rights shall be adjudicated according to them, being the
primary law between them. When the terms of the contract are clear and
leave no doubt as to the intention of the contracting parties, the rule is
settled that the literal meaning of its stipulations should control. 36
In the case at bar, there is no question that the bank breached the
Lease Contract. When it served upon Ragasa the Notice of Pre-termination
effective June 30, 2001 and when it, indeed, vacated the subject premises
on said date, the bank, in effect, breached item 2 of the Lease Contract,
providing for a five-year term. It must be noted that the Lease Contract
does not contain a pre-termination clause.
The Lease Contract has a specific provision in case of noncompliance of
its ‘‘Term’’ — ‘‘a period of five (5) years, commencing on February 1,
1998,’’ to wit:
8. The TENANT voluntarily binds himself and agrees to the
following without any coercion or force by the LESSOR;
x x x x
m) The full deposit shall be forfeited in favor of the LESSOR
upon noncompliance of the Term of the Con-
_______________
35  Rollo, pp. 63-66.
36  CIVIL CODE, Art. 1370; See Heirs of Manuel Uy Ek Liong v. Castillo,
710 Phil. 261, 275-276; 697 SCRA 294, 309 (2013).
 
 
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D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
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tract of Lease by the TENANT, and cannot be applied to Rental; 37
The word ‘‘term’’ appears only in three instances, but in three forms, in
the five-page Lease Contract. Firstly, ‘‘TERM’’ (a defined word as the
letters are all capitalized) is used in item 2, as quoted above, to indicate
the five-year period of the lease. Secondly, ‘‘Term’’ is used in item 8(m), as
quoted above, and being with a capitalized initial letter it also indicates
that it is a defined word. Lastly, it is provided in item 8(g) that the lessee
voluntarily binds itself and agrees: ‘‘To pay from time to time, during the
87 term of this Lease, all expenses such as salaries, wages, etc., if for
business, all charges for telephone if any, and/or any such other services in
the Leased Premises.’’38
 Given the fact that in item 2 and item 8(g), the words ‘‘TERM’’ and
‘‘term’’ definitely refer to the period of the lease, the word ‘‘Term’’ in item
8(m) should likewise be understood to have the same meaning.
The word ‘‘Term’’ could not mean stipulation, provision, condition,
covenant or clause as the word ‘‘term’’ can also be understood. In the
default clauses of the Lease Contract, i.e., items 8(p) and 10, the word
employed is ‘‘provisions.’’ It is the word ‘‘provisions’’ which the parties
intended to refer to any stipulation, condition, covenant or clause and not
the word ‘‘term.’’
Consequently, the correct interpretation of the word ‘‘Term’’ in item
8(m) is that it refers to the period of the lease, and not to any other
provision of the Lease Contract.
Article 1170 of the Civil Code mandates that those who, in the
performance of their obligations, are guilty of fraud, negligence, or delay,
and those who, in any manner, contravene the tenor thereof, are liable for
damages.
_______________
37  Rollo, pp. 64-65.
38  Id., at p. 65; underscoring supplied.
 
 
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Thus, having contravened the tenor of the Lease Contract regarding its
term or period, the bank should be liable for damages. However, how much
in damages should the bank be liable?
Generally, if the lessor or the lessee should not comply with their
obligations, the aggrieved party may ask for either the rescission of the
contract and indemnification for damages, or only the latter, allowing the
contract to remain in force.39
In the present case, there is an express stipulation in item 8(p) of the
Lease Contract that ‘‘[b]reach or noncompliance of any of the provisions of
this Contract, especially nonpayment of two consecutive monthly rentals
on time, shall mean the termination of this Contract.’’ 40
The validity of an automatic termination clause such as the one quoted
above is well-settled.
In Manila Bay Club Corporation v. Court of Appeals41 (Manila Bay Club
Corp.), the lease period agreed upon was from March 4, 1988 to March 4,
1998 but was short-lived because the private respondents therein
unilaterally terminated the lease with the request that petitioner therein
vacate the leased premises and peacefully surrender its possession for the
failure, among others, to insure the leased building in violation of
paragraph 22 of the lease contract between the parties therein. 42 The
private respondents therein invoked the ‘‘Special Clause’’ as found in
paragraph 19 of the said lease contract to justify their actions, to wit:
19. If the rental herein stipulated or any part thereof at any time,
shall be in arrears or unpaid, or if the tenant shall at any time fail or
neglect to perform or comply 
_______________
39  CIVIL CODE, Art. 1659.
40  Rollo, p. 65.
41  315 Phil. 805; 245 SCRA 715 (1995).
42  Id., at p. 811; p. 723.
 
 
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D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
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with any of the covenants, conditions, agreements or restrictions
stipulated or if the tenant shall become bankrupt or insolvent or
shall compound with his creditors, then and in any of such above
cases, this lease contract shall become automatically terminated
and cancelled and the said premises shall be peacefully vacated by
the LESSEE for the LESSOR to hold and enjoy henceforth as if these
89 presents have not been made and it shall be lawful for the LESSOR
or any person duly authorized in his behalf, without any formal
notice or demand to enter into and upon said leased premises or
any part thereof without prejudice on the part of the LESSOR to
exercise all rights on the contract of lease and those given by law.
And upon such cancellation of the contract, the LESSEE hereby
grants the LESSOR the legal right to enter into and take possession
of the leased premises as though the term of the leased contract
has expired.43
The Court justified the validity of the above automatic termination
clause, thus:
Certainly, there is nothing wrong if the parties to the lease contract
agreed on certain mandatory provisions concerning their respective
rights and obligations, such as the procurement of the insurance
and rescission clause. For it is well to recall that contracts are
respected as the law between the contracting parties, and may
establish such stipulations, clauses, terms and conditions as they
may want to include. As long as such agreements are not contrary
to law, morals, good customs, public policy or public order they shall
have the force of law between them.44
_______________
43  Id.
44  Id., at p. 826; p. 730, citing Pe v. Intermediate Appellate Court, 212-
A Phil. 94; 195 SCRA 137 (1991).

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In Riesenbeck v. Spouses Silvino Maceren, Jr. and Patricia
Maceren45 (Riesenbeck), the Court observed:
The Contract of Lease was called off by respondents in virtue of
Clauses No. 1046 and No. 1347 thereof to which the parties voluntarily
bound themselves. In Manila Bay Club Corp. v. Court of
Appeals,48 this Court interpreted as requiring mandatory compliance
by the parties a provision in a lease contract that failure or neglect
to perform or comply with any of the covenants, conditions,
agreements or restrictions stipulated shall result in the automatic
termination and cancellation of the lease.
In accord with this ruling is People’s Industrial and Commercial
Corp. v. Court of Appeals49 where the Court held that there is
nothing wrong if the parties to a lease contract agreed on certain
mandatory provisions concerning their respective rights and
obligations, such as the procurement of insurance and the rescission
clause.
Thus —
_______________
45  516 Phil. 157; 480 SCRA 362 (2006).
46  10. SUB-LEASE — The SUBSTITUTE LESSEE cannot sublease the
leased premises to any party without first securing the prior written
consent of the LESSOR, otherwise the sublease shall not be respected by
the latter;
47  13. VIOLATION AND DAMAGES — In case of violation of any terms
and conditions contained herein will be a ground for the offended party to
terminate the contract even before the end of its term and in case the
LESSEE violates the same the LESSOR have the option to terminate the
contract without prejudice to his rights to collect whatever rentals due for
the remaining years of the contract plus damages.
48  Manila Bay Club Corporation v. Court of Appeals, supra note 41 at
p. 826; p. 730.
49  346 Phil. 189, 202; 281 SCRA 206, 216 (1997), citing Manila Bay
Club Corporation v. Court of Appeals, id.; See also Subic Bay Metropolitan
Authority v. Universal International Group of Taiwan, 394 Phil. 691; 340
SCRA 359 (2000); Heirs of Juan San Andres v. Rodriguez, 388 Phil. 571,
586; 332 SCRA 769, 783 (2000).
 
 
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[I]t is well to recall that contracts are respected as the law
91
between the contracting parties, and they may establish such
stipulations, clauses, terms and conditions as they may want
to include. As long as such agreements are not contrary to
law, morals, good customs, public policy or public order they
shall have the force of law between them.
The foregoing legal truism finds equal potency in the case at bar.
No doubt, the pre-termination was properly resorted to by
respondents pursuant to Clause 10 of the Contract of Lease. Indeed,
the law on obligations and contracts does not prohibit parties from
entering into agreement providing that a violation of the terms of
the contract would cause its cancellation even without judicial
intervention.50 This is what petitioner and respondents entered into,
a lease contract with a stipulation that the contract is rescinded
upon violation of its substantial provisions, which petitioner, does
not deny having violated.51
Pursuant to the automatic termination clause of the Lease Contract,
which is in furtherance of the autonomy characteristic of contracts, the
Lease Contract was terminated upon its unauthorized pre-termination by
the bank on June 30, 2001. Ragasa is, thus, precluded from availing of the
second option which is to claim damages by reason of the breach and
allow the lease to remain in force. With the lease having been
automatically resolved or terminated by agreement of the parties, Ragasa
is entitled only to indemnification for damages.
To force either party to continue with a contract that is automatically
terminated in case of its breach by either party 
_______________
50  Pangilinan v. Court of Appeals, 345 Phil. 93; 279 SCRA 590
(1997); Jison v. Court of Appeals, 247 Phil. 304; 164 SCRA 339 (1988).
51  Riesenbeck v. Maceren, Jr., supra note 45 at pp. 170-171; p. 376.
 
 
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D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
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(pursuant to its express provision) is not in furtherance of or sanctioned by
the contract. Rather, it is a contravention thereof and it negates the
autonomy characteristic of contracts.
Is the claim of Ragasa that it is entitled to damages in the amount of
P3,146,596.42, representing the monthly rentals from July 1, 2001 to
January 31, 2003, or the unexpired period of the lease, valid?
Entitlement to rentals after the termination of the lease pursuant to an
automatic rescission or termination clause is possible in the case where
the lessor invokes the clause and the lessee refuses to vacate the leased
premises. The lessee will be liable for damages equivalent to the rentals
for the duration of its possession from the termination of the lease until he
vacates the premises. This was in effect the ruling of the Court in Manila
Bay Club Corp. when it affirmed the award of the monthly rental equivalent
to P250,000.00, which was the valuation of the trial court as affirmed by
the CA, viz.:
Petitioner in its third assignment of error assails the P250,000.00
monthly rental adjudged against it by the trial court and as affirmed
by respondent Court of Appeals, claiming that there was no basis for
such finding.
Again, we disagree. In reaching that amount, the trial court took
into consideration the following factors: 1) prevailing rates in the
vicinity; 2) location of the property; 3) use of the property; 4)
inflation rate; and 5) the testimony of private respondent Modesta
Sabeniano that she was offered by a Japanese-Filipino investor a
monthly rental of P400,000.00 for the leased premises then
occupied by petitioner.52 Petitioner for its part should have
presented its controverting evidence below to support what it
believes to be the fair rental value of the leased building since the
burden of proof to show that  95
_______________
52  Citation of the Rollo omitted.
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94 SUPREME COURT REPORTS ANNOTATED
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the rental demanded is unconscionable or exorbitant rests upon the
lessee.53 But petitioner failed to do so. Hence, the valuation by the
trial court, as affirmed by respondent Court of Appeals, stands.
   It is worth stressing at this juncture that the trial court had the authority
to fix the reasonable value for the continued use and occupancy of the
leased premises after the termination of the lease contract, and that it was
not bound by the stipulated rental in the contract of lease since it is
equally settled that upon termination or expiration of the contract of lease,
the rental stipulated therein may no longer be the reasonable value for the
use and occupation of the premises as a result or by reason of the change
or rise in values.54 Moreover, the trial court can take judicial notice of the
general increase in rentals of real estate especially of business
establishments55 like the leased building owned by private respondents. 56
That is, however, not the situation here. The bank did not continue to
possess the Leased Premises after its automatic termination, as it vacated
the same on June 30, 2001.
As explained above, the provision or clause that is applicable in case of
noncompliance of the Term or period of the Lease Contract is item 8(m)
which mandates that the full deposit of P367,821.00 or the equivalent of
three months rentals shall be forfeited with the proviso that the deposit
cannot be applied to rental. This proviso as to non-application to rental of
the deposit means that the forfeiture is without prejudice to the payment
of any unpaid rental at the time of
_______________
53  Citing Shoemart, Inc. v. Court of Appeals, 268 Phil. 195, 204-205;
190 SCRA 189, 197 (1990).
54  Citing Limcay v. Court of Appeals, 289 Phil. 429, 437; 215 SCRA 1, 9
(1992).
55  Citing Commander Realty, Inc. v. Court of Appeals, 250 Phil. 190,
192; 168 SCRA 181, 183-184 (1988).
56  Manila Bay Club Corporation v. Court of Appeals, supra note 41 at
pp. 827-828; p. 732.
 
 
VOL. 867, JUNE 20, 2018 95
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the noncompliance or breach of the Term or period of the Lease Contract.
Since the bank had no unpaid rental as of June 30, 2001, the proviso finds
no application in the present case.
What is the nature of item 8(m) of the Lease Contract: ‘‘The full deposit
shall be forfeited in favor of the LESSOR upon noncompliance of the Term
of the Contract of Lease by the TENANT, and cannot be applied to Rental?’’
The Court believes and so holds that item No. 8(m) is a penalty or penal
clause.
A penal clause is an accessory obligation which the parties attach to a
principal obligation for the purpose of insuring the performance thereof by
imposing on the debtor a special prestation (generally consisting in the
payment of a sum of money) in case the obligation is not fulfilled or is
irregularly or inadequately fulfilled. 57 Quite common in lease contracts, this
clause functions to strengthen the coercive force of the obligation and to
provide, in effect, for what would be the liquidated damages resulting from
a breach.58
A penal clause has a three-fold purpose: (1) a coercive purpose or one
of guarantee — this is to urge the debtor to the fulfillment of the main
obligation under pain of paying the penalty; (2) to serve as liquidated
damages — this is to evaluate in advance the damages that may be
occasioned by the noncompliance of the obligation; and (3) a strictly penal
purpose — this is to punish the debtor for nonfulfillment of the main
obligation.59 While the first purpose is always present,
_______________
 57  Pryce Corporation v. Philippine Amusement and Gaming
Corporation, 497 Phil. 490, 508; 458 SCRA 164, 180 (2005).
58  Id.
59  Caguioa, Eduardo P., Comments and Cases on Civil Law, Civil Code
of The Philippines, Vol. IV, p. 284, Rev. Second ed. (1983).
 
 
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96 SUPREME COURT REPORTS ANNOTATED
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the second purpose is presumed and the third purpose must be expressly
agreed upon.60
Stated otherwise, the purposes of penalty or penal clause are:
(1) funcion coercitiva o de guarantia or to insure the performance of the
obligation; (2) funcion liquidatoria or to liquidate the amount of damages
to be awarded to the injured party in case of breach of the principal
obligation; and (3) funcion estrictamente penal or to punish the obligor in
case of breach of the principal obligation, in certain exceptional
cases.61 The second is evidently compensatory and the third is punitive in
character, while the first is the general purpose regardless of whether the
penalty is compensatory or punitive. 62
Evidently, the penal clause may be considered either reparation,
compensation or substitute for damages, on one hand, or as a punishment
in case of breach of the obligation, on the other. When considered as
reparation or compensation, the question as to the appropriate amount of
damages is resolved once and for all because the stipulated indemnity
represents a legitimate estimate made by the contracting parties of the
damages caused by the nonfulfillment or breach of the obligation. Proof of
actual damages is, consequently, not necessary in order that the stipulated
penalty may be demanded. When considered as a punishment, the
question of damages is not yet resolved inasmuch as the right to damages,
besides the penalty, still subsists. Thus, if the injured party desires to
recover the damages actually suffered by him in addition to the penalty, he
must prove such damages.63
_______________
60  Id.
61  Jurado, Desiderio P., Comments and Jursiprudence on Obligations
and Contracts, p. 207, Ninth Rev. ed. (1987), citing Castan, Vol. 3, pp. 100-
101, 7th ed.
62  Id., at p. 207.
63  Id., at p. 208.
 
 
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Penal clause may be classified into: (1) according to source: (a) legal
(when it is provided by law) and (b) conventional (when it is provided for
by stipulation of the parties); (2) according to demandability: (a) subsidiary
(when only the penalty may be enforced) and (b) complementary (when
both the principal obligation and the penalty may be enforced); and (3)
according to purpose: (a) cumulative (when damages may be collected in
addition to penalty) and (b) reparatory (when the penalty substitutes
indemnity for damages).64
Item 8(m) of the Lease Contract is an accessory obligation or prestation
to the principal obligation of lease. It specifies the stipulated amount of
liquidated damages — the full deposit — to be awarded to the injured party
in case of breach of the Term or period of the principal obligation. Hence,
as to source, it is conventional.
As defined, liquidated damages are those agreed upon by the parties to
a contract, to be paid in case of breach thereof. 65 The amount of the
liquidated damages is purely contractual between the parties; and the
courts will intervene only to equitably reduce the liquidated damages,
whether intended as an indemnity or a penalty, if they are iniquitous or
unconscionable, pursuant to Articles 2227 and 1229 66 of the Civil Code.
Also, proof of actual damages suffered by the creditor is not necessary
in order that the penalty may be demanded. 67
_______________
64  Caguioa, supra note 59 at p. 279.
65  CIVIL CODE, Art. 2226.
66  Id., Art. 1229 provides:
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.
67  Id., Art. 1228.
 
 
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D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
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Item 8(m) seeks to insure or guarantee the completion of the lease
period since its noncompliance shall be met with a penalty. The degree of
the coercive effect or impact of the penalty to insure or guarantee the
performance of the principal obligation depends largely on the stipulated
amount of the liquidated damages. If the amount is substantial, then the
compulsion to perform may be greater. The obligor may not, however, be
willing to accept a very stiff penalty. As expressed earlier, the amount is
97 purely discretionary on the parties provided that it will pass the test of
unconscionability or excessiveness. Since the herein parties have agreed
on a specific amount of penalty, P367,821.00 or the full deposit, the Court
will not even second guess whether it is substantial enough to insure the
compliance of the lease period. The Court will simply rule that it is
reasonable.
As to the effect of the penal clause, Article 1226 of the Civil Code
provides:
Art. 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.
From the first paragraph of Article 1226, it is evident that, as a rule, the
penalty is fixed by the contracting parties as a compensation or substitute
for damages in case of breach of the obligation; and it is, therefore, clear
that the penalty in its compensatory aspect is the general rule, while the
penalty in its strictly penal aspect is the exception. 68
_______________
68  Supra note 61 at pp. 208-209.
99
VOL. 867, JUNE 20, 2018
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
It is also clear from paragraph 1 of Article 1226 that when an obligation
or a contract contains a penal clause, the penalty shall substitute the
indemnity for damages and the payment of interests in case of
noncompliance with or breach of the principal obligation. This general rule,
however, admits three exceptions, namely: (1) when there is a stipulation
to the contrary; (2) when the obligor or debtor is sued for refusal to pay the
agreed penalty; and (3) when the obligor or debtor is guilty of fraud. In
these exceptions, it is evident that the purpose of the penalty is to punish
since the obligee or creditor can recover from the obligor or debtor not
only the penalty, but also the damages or interests resulting from the
breach of the principal obligation. 69
Is item 8(m) intended by the parties for a strictly penal purpose or a
punishment on the guilty party? If it is, then item 8(m) is both
complementary and cumulative. If it is not, then it is subsidiary and
reparatory.
As earlier observed, the third purpose of a penal clause, which is strictly
penal, must be expressly agreed upon. This is in consonance with the first
sentence of Article 1226 — ‘‘the penalty shall substitute the indemnity for
damages and interests in case of noncompliance, if there is no stipulation
to the contrary.’’ Thus, the contract must expressly provide that in addition
to the penalty, the guilty party shall be liable for damages or interests
resulting from the breach of the principal obligation.
Item 8(m) does not expressly make a reservation for an additional
claim for damages and interests occasioned by the breach of the lease
period. There is, however, another provision of the Lease Contract that is
triggered by a default in item 8(m), to wit:
_______________
69  Id., at pp. 210-211.
 
 
100
100 SUPREME COURT REPORTS ANNOTATED
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
10. In the event that a Court Litigation has been resorted to by
the LESSOR or LESSEE, due to noncompliance of any of the
foregoing provisions, the aggrieved party shall be paid by the other
party, no less than fifteen thousand (P15,000) pesos, Philippine
Currency, for Attorney’s fees, and other damages that the honorable
court may allow; the cost of litigations shall be born[e] or paid by
the party in fault, or in default. All unpaid accounts and obligations
of the TENANT shall earn interest or bear interest at the rate of
14% per annum or at the allowable rate of interest from the date of
default. The legal suits shall be brought in the town of Quezon
99 City.70 (Underscoring supplied)
Being provisions on default, item 8(m) and item 10 must be applied
jointly and simultaneously. Thus, aside from the forfeiture of the full
deposit, the party at fault or in default is liable, pursuant to item 10 of the
Lease Contract, for the payment of attorney’s fees in an amount which is
not less than P15,000.00, other damages that the court may allow, cost of
litigation, and 14% interest per annum on unpaid accounts and obligations.
Can item 10 pass as the ‘‘stipulation to the contrary’’ or the express
agreement required in Article 1226? A careful reading of all the pertinent
provisions leads the Court to believe that when item 10 provides that
‘‘other damages that the court may allow’’ are recoverable in case of
noncompliance of any provision of the Lease Contract, this only means
what it says, that the aggrieved party can be awarded damages in addition
to the forfeiture of the deposit that is provided in item 8(m). In fine, item
8(m) and item 10, construed together, form a complementary and
cumulative penal clause; and it is a punishment or strictly penal.
From the foregoing, the Court accordingly rules that the bank is liable
for the forfeiture of the deposit and attorney’s
_______________
70  Rollo, p. 66.
 
  
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D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
fees in the amount of P15,000.00 and such other damages which Ragasa
suffered by reason of the breach of the lease period by the bank.
Clearly, the requisites for the demandability of the penal clause are
present in this case. These are: (1) that the total nonfulfillment of the
obligation or the defective fulfillment is chargeable to the fault of the
debtor; and (2) that the penalty may be enforced in accordance with the
provisions of law. As to the second requisite, the penalty is demandable
when the debtor is in mora in regard to obligations that are positive (to
give and to do) where demand may be necessary unless it is excused; and
with regard to negative obligations, when an act is done contrary to that
which is prohibited.71
In the present case, the bank pre-terminated the Lease Contract which
is not expressly allowed therein. For not complying with its Term or period,
the bank did an act contrary to what is not allowed in the Lease Contract.
Additionally, the bank cannot insist on paying only the penalty. This is
proscribed under Article 1227, to wit:
Art. 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
to require the fulfillment of the obligation, the performance thereof
should become impossible without his fault, the penalty may be
enforced.
 
There is nothing in the Lease Contract which provides that the bank can
exempt itself from the performance of any provision therein, including the
Term or period, by simply paying
_______________
71  Supra note 59 at p. 280.
 
102
102 SUPREME COURT REPORTS ANNOTATED
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
the penalty. Items 8(m) and 10 do not contain any such exemption.
As discussed above, Ragasa cannot insist on the performance of the
lease, i.e., for the lease to continue until expiration of its term, because the
lease has been automatically terminated when the bank breached it by
pre-terminating its terms. Thus, Ragasa is only entitled to damages.
That said, that is, even as items 8(m) and 10 are considered strictly
101
penal or punishment, Ragasa, as the injured party, is nonetheless required
to prove the ‘‘other damages” that it actually suffered before it can be
entitled thereto. However, a review of the records shows that Ragasa
presented nothing. Ragasa simply insisted that the bank should be liable
for the amount representing the monthly rentals from July 1, 2001 up to
January 31, 2003 or the unexpired term of the Lease Contract, equivalent
to P3,146,596.42. Ragasa did not adduce any evidence to support its claim
that it actually suffered damages of such amount in terms of lost income.
In this regard, it must be emphasized that Ragasa could have leased the
Leased Premises as early as July 1, 2001 because the bank had completely
vacated the same as of June 30, 2001. That Ragasa chose not to lease the
Leased Premises and not earn any rental therefrom in the meantime that
its complaint for damages against the bank was being litigated was its own
decision and doing.
Article 2203 of the Civil Code provides that ‘‘[t]he party suffering loss or
injury must exercise the diligence of a good father of a family to minimize
the damages resulting from the act or omission.’’ Ragasa likewise failed in
this respect.
In conclusion, the Court rules that Ragasa is not entitled to the rental
for the unexpired period of the Lease Contract, and it is only entitled to the
forfeiture of the full deposit pursuant to item 8(m) and P15,000.00 as
attorney’s fees pursuant to item 10.
 
 
103
VOL. 867, JUNE 20, 2018 103
D.M. Ragasa Enterprises, Inc. vs. Banco De Oro, Inc. (formerly Equitable PCI Bank,
Inc.)
WHEREFORE, premises considered, the instant petition for review is
hereby partly GRANTED. The Decision dated March 27, 2009 and the
Resolution dated November 25, 2009 of the CA are AFFIRMED WITH
MODIFICATION, awarding attorney’s fees in the amount of P15,000.00 in
favor of petitioner D.M. Ragasa Enterprises, Inc.
SO ORDERED.
Carpio** (Chairperson), Peralta, Perlas-Bernabe and A. Reyes, Jr., JJ.,
concur.
Petition granted, judgment and resolution affirmed with modification.
Notes.—A penal clause is an accessory undertaking attached to a
principal obligation. (Buenaventura vs. Metropolitan Bank and Trust
Company, 799 SCRA 239 [2016])
Section 17 of the Omnibus Rules implementing the Civil Service Law
states that if the respondent judge is found guilty of two (2) or more
charges or counts, the penalty imposed should be that corresponding to
the most serious charge or counts and the rest may be considered
aggravating circumstances. (Re: Findings on the Judicial Audit Conducted
in Regional Trial Court, Branch 8, La Trinidad, Benguet, 819 SCRA 274
[2017])

 
——o0o——
_______________

** Designated Senior Associate Justice per Section 12, R.A. 296, The
Judiciary Act of 1948, as amended.

 
© Copyright 2020 Central Book Supply, Inc. All rights reserved.
 G.R. No. 185765. September 28, 2016. *
 
PHILIPPINE ECONOMIC ZONE AUTHORITY, petitioner, vs. PILHINO SALES
CORPORATION, respondent.
Civil Law; Sales; Contract of Sale; Reciprocal Obligations; A contract
of sale entails reciprocal obligations.—A contract of sale, such as that
entered into by petitioner and respondent, entails reciprocal obligations. As
explained in Spouses Velarde v. Court of Appeals, 361 SCRA 56 (2001),
“[i]n a contract of sale, the seller obligates itself to transfer the ownership
of and deliver a determinate thing, and the buyer to pay therefor a price
certain in money or its equivalent.”
Same; Contracts; Rescission; Jurisprudence has long settled that the
restoration of the contracting parties to their original state is the very
essence of rescission.—Respondent correctly notes that rescission under
Article 1911 results in mutual restitution. Jurisprudence has long settled
that the restoration of the contracting parties to their original state is the
very essence of rescission. In Spouses Velarde v. Court of Appeals, 361
SCRA 56 (2001): Considering that the rescission of the contract is based on
Article 1191 of the Civil Code, mutual restitution is required to bring back
the parties to their original situation prior to the inception of the contract.
Accordingly, the initial payment of P800,000 and the corresponding
mortgage payments . . . should be returned by private respondents, lest
the latter unjustly enrich themselves at the expense of the former.
Rescission creates the obligation to return the object of the contract. It can
be carried out only when the one who demands rescission can return
whatever he may be obliged to restore. To rescind is to declare a contract
void at its inception and to put an end to it as though it never was. It is not
merely to terminate it and release the parties from further obligations to
each other, but to abrogate it from the beginning and restore the parties to
their relative positions as if no contract has been made.
_______________
*  SECOND DIVISION.
 
 
267
VOL. 804, SEPTEMBER 28, 2016 267
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
Same; Same; Same; Liquidated Damages; Mutual restitution under
Article 1191 is no license for the negation of contractually stipulated
liquidated damages.—Contrary to respondent’s assertion, mutual
restitution under Article 1191 is, however, no license for the negation of
contractually stipulated liquidated damages. Article 1191 itself clearly
states that the options of rescission and specific performance come with
“with the payment of damages in either case.” The very same breach or
delay in performance that triggers rescission is what makes damages due.
When the contracting parties, by their own free acts of will, agreed on what
these damages ought to be, they established the law between themselves.
Their contemplation of the consequences proper in the event of a breach
has been articulated. When courts are, thereafter, confronted with the
need to award damages in tandem with rescission, courts must not lose
sight of how the parties have explicitly stated, in their own language, these
consequences. To uphold both Article 1191 of the Civil Code and the
parties’ will, contractually stipulated liquidated damages must, as a rule,
be maintained.
Bids and Bidding; Jurisprudence has established the impropriety of
modifying awarded contracts that were previously subjected to public
bidding.—Respondent’s attempt at rectification came too late and under
such circumstances that petitioner was no longer even in a position to
accept respondent’s offer. As petitioner notes, by the time respondent
made its offer, the Complaint for rescission and damages had already been
filed before the Regional Trial Court of Pasay City. If at all, the offer was
nothing more than a belated reaction to undercut litigation. By the time
respondent made its attempt at rectification, petitioner was no longer
capable of accommodating contractual modifications. Jurisprudence has
established the impropriety of modifying awarded contracts that were
previously subjected to public bidding, such as that between petitioner and
respondent: An essential element of a publicly bidded contract is that all
bidders must be on equal footing. Not simply in terms of application of the
procedural rules and regulations imposed by the relevant government
agency, but more importantly, on the contract bidded upon. Each bidder
must be able to bid on the same thing. The rationale is obvious. If the
winning bidder is allowed to later include or modify certain provisions in
the contract awarded such that the contract is altered in any material
respect, then the essence of fair competition in the public bidding is
destroyed. A public bidding would indeed be a
 
 
268
268 SUPREME COURT REPORTS ANNOTATED
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
farce if after the contract is awarded, the winning bidder may
modify the contract and include provisions which are favorable to it that
were not previously made available to the other bidders.
Damages; Liquidated Damages; Words and Phrases; By definition,
liquidated damages are a penalty, meant to impress upon defaulting
obligors the graver consequences of their own culpability.—By definition,
liquidated damages are a penalty, meant to impress upon defaulting
obligors the graver consequences of their own culpability. Liquidated
damages must necessarily make noncompliance more cumbersome than
compliance. Otherwise, contracts might as well make no threat of a
penalty at all: Liquidated damages are those that the parties agree to be
paid in case of a breach. As worded, the amount agreed upon answers for
damages suffered by the owner due to delays in the completion of the
project. Under Philippine laws, these damages take the nature of penalties.
A penal clause is an accessory undertaking to assume greater liability in
case of a breach. It is attached to an obligation in order to ensure
performance.
PETITION for review on certiorari of the decision and resolution of the Court
of Appeals.
The facts are stated in the opinion of the Court.
   Office of the Solicitor General for petitioner.
   Virgilio C. Gener for respondent.
LEONEN, J.:
Although the provisions of a contract are legally null and void, the
stipulated method of computing liquidated damages may be accepted as
evidence of the intent of the parties. The provisions, therefore, can be
basis for finding a factual anchor for liquidated damages. The liable party
may nevertheless present better evidence to establish a more accurate
basis for awarding damages. In this case, the respondent failed to do so.
 
 
269
VOL. 804, SEPTEMBER 28, 2016 269
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
This resolves a Petition for Review on Certiorari1 praying that the
assailed May 2, 2008 Decision 2 and November 25, 2008 Resolution 3 of the
Court of Appeals in C.A.-G.R. CV No. 86406 be reversed and set aside and
that the Decision4 dated November 2, 2005 of Branch 108 of the Regional
Trial Court of Pasay City in Civil Case No. 00-0343 be reinstated.
The Regional Trial Court’s November 2, 2005 Decision ruled in favor of
petitioner Philippine Economic Zone Authority, which, as plaintiff, brought
an action for rescission of contract and damages against the defendant,
now respondent Pilhino Sales Corporation (Pilhino).5
The assailed Court of Appeals’ Decision partly granted Pilhino’s appeal
by reducing the amount of liquidated damages due from it to the Philippine
Economic Zone Authority, and by deleting the forfeiture of its performance
bond.6 The assailed Court of Appeals Resolution denied the Philippine
Economic Zone Authority’s Motion for Reconsideration. 7
The facts are not disputed, and all that is in issue is the consequence of
Pilhino’s contractual breach.
On October 4, 1997, the Philippine Economic Zone Authority published
an invitation to bid in the Business Daily for its
_______________
1  Rollo, pp. 14-33. The Petition was filed under Rule 45 of the 1997
Rules of Civil Procedure.
2  Id., at pp. 35-58. The Decision was penned by Associate Justice Celia
C. Librea-Leagogo and concurred in by Associate Justices Regalado E.
Maambong and Agustin S. Dizon of the Sixteenth Division, Court of
Appeals, Manila.
3  Id., at pp. 60-61. The Resolution was penned by Associate Justice
Celia C. Librea-Leagogo and concurred in by Associate Justices Josefina
Guevarra-Salonga and Regalado E. Maambong of the Special Former
Sixteenth Division, Court of Appeals, Manila.
4  Id., at pp. 62-65. The Decision was penned by Pairing Judge
Tingaraan U. Guiling.
5  Id., at p. 65.
6  Id., at p. 55.
7  Id., at p. 61.
 
270
270 SUPREME COURT REPORTS ANNOTATED
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
acquisition of two (2) brand new fire truck units “with a capacity of 4,000-
5,000 liters [of] water and 500-1,000 liters [of chemical foam,] with
complete accessories.”8
Three (3) companies participated in the bidding: Starbilt Enterprise,
Inc., Shurway Industries, Inc., and Pilhino. 9 Pilhino secured the contract for
the acquisition of the fire trucks. 10 The contract price was initially at
P3,000,000.00 per truck, but this was reduced after negotiation to
P2,900,000.00 per truck.11
The contract awarded to Pilhino stipulated that Pilhino was to deliver to
the Philippine Economic Zone Authority two (2) FF3HP brand fire trucks
within 45 days of receipt of a purchase order from the Philippine Economic
Zone Authority.12 A further stipulation stated that “[i]n case of fail[u]re to
deliver the . . . good on the date specified . . . , the Supplier agree[s] to pay
penalty at the rate of 1/10 of 1% of the total contract price for each days
[sic] commencing on the first day after the date stipulated above.” 13
The Philippine Economic Zone Authority furnished Pilhino with a
purchase order dated November 6, 1997. 14 Pilhino failed to deliver the
trucks as it had committed. 15 This prompted the Philippine Economic Zone
Authority to make formal demands on Pilhino on July 27, 1998 16 and on
February 23, 1999.17 As Pilhino still failed to comply, the Philippine
Economic Zone Authority filed before the Regional Trial Court
_______________
8   Id., at p. 62.
9   Id.
10  Id.
11  Id.
12  Id.
13  Id., at pp. 75-77.
14  Id.
15  Id., at p. 78.
16  Id.
17  Id., at p. 79.
  
271
VOL. 804, SEPTEMBER 28, 2016 271
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
of Pasay City a Complaint18 for rescission of contract and damages. This
was docketed as Civil Case No. 00-0343 and raffled to Branch 108. 19
In its defense, Pilhino claimed that there was no starting date from
which its obligation to deliver could be reckoned, considering that the
Complaint supposedly failed to allege acceptance by Pilhino of the
purchase order.20 Pilhino suggested that there was not even a meeting of
minds between it and the Philippine Economic Zone Authority. 21
In its November 2, 2005 Decision, 22 the Regional Trial Court ruled for
the Philippine Economic Zone Authority. The dispositive portion of the
Decision reads:
WHEREFORE, judgment is hereby rendered in favor of the plaintiff and
against the defendant ordering the latter to:
1. Pay the plaintiff in liquidated damages a[t] the rate of 1/10 of 1% of
the total contract price of Php5,800,000.00 for each day of delay
commencing from June 19, 1998.
2. Pay the plaintiff exemplary damages in the amount of
Php100,00[0].00.
3. That the contract be declared rescinded and the performance bond
posted by the defendant be forfeited in favor of the plaintiff.
4. For defendant to pay the cost of the suit.
SO ORDERED.23
 
Pilhino then appealed before the Court of Appeals.
_______________
18  Id., at pp. 80-85.
19  Id., at p. 62.
20  Id., at p. 37.
21  Id., at p. 38.
22  Id., at pp. 62-65.
23  Id., at p. 65.
 
 
272
272 SUPREME COURT REPORTS ANNOTATED
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
In its assailed May 2, 2008 Decision, 24 the Court of Appeals partly
granted Pilhino’s appeal by deleting the forfeiture of Pilhino’s performance
bond and pegging the liquidated damages due from it to the Philippine
Economic Zone Authority in the amount of P1,400,000.00.
The Court of Appeals debunked Pilhino’s claim that there was no
meeting of minds. It emphasized that Pilhino “manifested its
acquiescence . . . [to] the Purchase Order . . . when it submitted to [the
Philippine Economic Zone Authority] a Performance Bond dated 02 June
1999 and Indemnity Agreement dated 09 June 1998 duly signed by its Vice
President.”25 It added that in a subsequent letter dated March 29,
199926 “signed by [Pilhino’s] Hino Division Manager Edgar R. Santiago and
noted by VP-Operations Roberto R. Garcia, [Pilhino] admitted that it can no
longer meet the requirements regarding the specification on the two (2)
units of fire truck[s].”27
In this March 29, 1999 letter, Pilhino not only acknowledged its inability
to meet its obligations but also proposed a modified arrangement with the
Philippine Economic Zone Authority:
[P]lease allow us to submit our new proposal for your consideration (please
see attached specifications). Our price for this new specification if
P3,600,000.00/unit. However, we are willing to shoulder the difference
between the original price of P2,900,000.00/unit and P3,600,000.00 in lieu
of the penalty. May we also request your good office to stop the
accumulation of the penalty[.]28
 
In calibrating the amount of liquidated damages, the Court of Appeals
cited Articles 122929 and 222730 of the Civil Code. It
_______________
24  Id., at pp. 35-56.
25  Id., at p. 51.
26  Id., at p. 50.
27  Id., at p. 51.
28  Id., at p. 50.
29  CIVIL CODE, Art. 1229 provides:
 
273
VOL. 804, SEPTEMBER 28, 2016 273
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
reasoned that through its March 29, 1999 letter, Pilhino made an attempt
at rectification or mitigation:
In the instant case, we consider the supervening reality that after
appellant’s failure to deliver to appellee the two (2) brand new units of fire
trucks in accordance with the specifications previously agreed upon,
appellant nevertheless tried to remedy the situation by offering to appellee
new specifications at P3,600,000.00 per unit; and expressed willingness to
shoulder the difference between the original price (based on the contract)
of P2,900,000.00 per unit and the price corresponding to the new
specifications. Further, it is undisputed that appellee has not paid any
amount to appellant in connection with said undelivered two (2) brand new
units of fire trucks. We thus equitably reduce said liquidated damages to
P1,400,000.00, which is the difference between the contract price of
P5,800,000.00 and P7,200,000.00 based on the new specifications for two
(2) new units of fire trucks.31
 The Philippine Economic Zone Authority moved for reconsideration of 33  Id., at p. 23.
the modifications to the Regional Trial Court’s award. As this Motion was 34  Id., at pp. 24-26.
denied in the Court of Appeals’ assailed November 25, 2008 35  Id., at pp. 26-27.
Resolution,32 the Philippine Economic Zone Authority filed the present 36  Id., at p. 26.
Petition. 37  Id., at pp. 27-28.
_______________ 38  Id., at p. 24.
39  Id., at pp. 232-241.
Article 1229. The judge shall equitably reduce the penalty when 40  Id., at p. 238.
the principal obligation has been partly or irregularly complied with 41  Id., at pp. 238-239.
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.  
30  CIVIL CODE, Art. 2227 provides: 275
Article 2227. Liquidated damages, whether intended as an VOL. 804, SEPTEMBER 28, 2016 275
indemnity or a penalty, shall be equitably reduced if they are
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
iniquitous or unconscionable.
We resolve the twin issues of:
31  Rollo, pp. 54-55.
First, the propriety of an award based on contractually stipulated
32  Id., at pp. 60-61.
liquidated damages notwithstanding the rescission of the same contract
  stipulating it; and
  Second, on the assumption that such award is proper, the propriety of
274 the Court of Appeals’ reduction of the liquidated damages due to
petitioner.
274 SUPREME COURT REPORTS ANNOTATED  
Philippine Economic Zone Authority vs. Pilhino Sales Corporation I
Petitioner asks for the reinstatement of the Regional Trial Court’s award  
asserting that it already suffered damage when respondent Pilhino Sales Respondent’s intimation that with the rescission of a contract
Corporation failed to deliver the trucks on time; 33 that the contractually necessarily and inexorably follows the obliteration of liability for what the
stipulated penalty of 1/10 of 1% of the contract price for every day of delay same contracts stipulates as liquidated damages 42 is entirely misplaced.
was neither unreasonable34 nor contrary to law, morals, or public A contract of sale, such as that entered into by petitioner and
order;35 that the stipulation on liquidated damages was freely entered into respondent, entails reciprocal obligations. As explained in Spouses Velarde
by it and respondent; 36 and that the Court of Appeals’ computation had no v. Court of Appeals,43 “[i]n a contract of sale, the seller obligates itself to
basis in fact and law.37 Regarding respondent’s supposed attempt at transfer the ownership of and deliver a determinate thing, and the buyer to
mitigation, petitioner notes that by the time the offer was made, the pay therefor a price certain in money or its equivalent.” 44
Complaint for rescission and damages had already been filed 38 and was, Rescission on account of breach of reciprocal obligations is provided for
therefore, inconsequential and hardly a remedy. in Article 1191 of the Civil Code:
Commenting on petitioner’s Petition, 39 respondent raises the question Article 1191. The power to rescind obligations is implied in reciprocal
of: ones, in case one of the obligors should not comply with what is incumbent
Whether or not a contract can be rescinded and declared void ab initio, upon him.
and then thus rescinded, can a stipulation for liquidated damages or  
penalty contained in that very same contract be given separate life, force The injured party may choose between the fulfillment and the
and effect, that is, separate and distinct from the rescinded and voided rescission of the obligation, with the payment of damages in either case.
contract itself?40 He may also seek rescis-

  _______________
Therefore, respondent suggests that with the rescission of its contract
with petitioner must have come the negation of the contractual stipulation 42  CIVIL CODE, Art. 2226 provides:
on liquidated damages and the obliteration of its liability for such Article 2226. Liquidated damages are those agreed upon by the
liquidated damages.41 parties to a contract, to be paid in case of breach thereof.
_______________ 43  413 Phil. 360; 361 SCRA 56 (2001) [Per J. Panganiban, Third
Division].
 44  Id., at p. 372; p. 66.
 
 
276
276 SUPREME COURT REPORTS ANNOTATED
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
sion, even after he has chosen fulfillment, if the latter should become
impossible.
The court shall decree the rescission claimed, unless there be just
cause authorizing the fixing of a period.
This is understood to be without prejudice to the rights of third persons
who have acquired the thing, in accordance with articles 1385 and 1388
and the Mortgage Law. (Emphasis supplied)
 
Respondent correctly notes that rescission under Article 1911 results in
mutual restitution. Jurisprudence has long settled that the restoration of
the contracting parties to their original state is the very essence of
rescission. In Spouses Velarde:
Considering that the rescission of the contract is based on Article 1191
of the Civil Code, mutual restitution is required to bring back the parties to
their original situation prior to the inception of the contract. Accordingly,
the initial payment of P800,000 and the corresponding mortgage payments
. . . should be returned by private respondents, lest the latter unjustly
enrich themselves at the expense of the former.
Rescission creates the obligation to return the object of the contract. It
can be carried out only when the one who demands rescission can return
whatever he may be obliged to restore. To rescind is to declare a contract
void at its inception and to put an end to it as though it never was. It is not
merely to terminate it and release the parties from further obligations to
each other, but to abrogate it from the beginning and restore the parties to
their relative positions as if no contract has been made. 45 (Citations
omitted)
_______________
45  Id., at p. 375; pp. 69-70.
 
 
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Laperal v. Solid Homes, Inc. 46 has explained how the restitution spoken
of in rescission under Article 1385 of the Civil Code equally holds true for
rescission under Article 1191 of the Civil Code:
Despite the fact that Article 1124 of the old Civil Code from whence
Article 1191 was taken, used the term “resolution,” the amendment
thereto (presently, Article 1191) explicitly and clearly used the term
“rescission.” Unless Article 1191 is subsequently amended to revert back
to the term “resolution,” this Court has no alternative but to apply the law,
as it is written.
Again, since Article 1385 of the Civil Code expressly and clearly states
that “rescission creates the obligation to return the things which were the
object of the contract, together with their fruits, and the price with its
interest,” the Court finds no justification to sustain petitioners’ position
that said Article 1385 does not apply to rescission under Article 1191.
In Palay, Inc. v. Clave, this Court applied Article 1385 in a case involving
“resolution” under Article 1191, thus:
Regarding the second issue on refund of the installment
payments made by private respondent. Article 1385 of the Civil
Code provides:
“ART. 1385. Rescission creates the obligation to return
the things which were the object of the contract, together
with their fruits, and the price with its interest; consequently,
it can be carried out only when he who demands rescission
can return whatever he may be obliged to restore.
_______________
46  499 Phil. 367; 460 SCRA 375 (2005) [Per J. Garcia, Third Division].
 
 
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278 SUPREME COURT REPORTS ANNOTATED
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
“Neither shall rescission take place when the things which
are the object of the contract are legally in the possession of
third persons who did not act in bad faith.
“In this case, indemnity for damages may be demanded
from the person causing the loss.”
As a consequence of the resolution by petitioners, rights to the
lot should be restored to private respondent or the same should be
replaced by another acceptable lot. However, considering that the
property had already been sold to a third person and there is no
evidence on record that other lots are still available, private
respondent is entitled to the refund of installments paid plus interest
at the legal rate of 12% computed from the date of the institution of
the action. It would be most inequitable if petitioners were to be
allowed to retain private respondent’s payments and at the same
time appropriate the proceeds of the second sale to another.
Applying the clear language of the law and the consistent jurisprudence
on the matter, therefore, the Court rules that rescission under Article 1191
in the present case, carries with it the corresponding obligation of
restitution.47 (Citations omitted)
  
Contrary to respondent’s assertion, mutual restitution under Article
1191 is, however, no license for the negation of contractually stipulated
liquidated damages.
Article 1191 itself clearly states that the options of rescission and
specific performance come with “with the payment of damages in either
case.” The very same breach or delay in
_______________
47  Id., at pp. 379-380; pp. 386-387.
 
 
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Philippine Economic Zone Authority vs. Pilhino Sales Corporation
performance that triggers rescission is what makes damages due.
When the contracting parties, by their own free acts of will, agreed on
what these damages ought to be, they established the law between
themselves. Their contemplation of the consequences proper in the event
of a breach has been articulated. When courts are, thereafter, confronted
with the need to award damages in tandem with rescission, courts must
not lose sight of how the parties have explicitly stated, in their own
language, these consequences. To uphold both Article 1191 of the Civil
Code and the parties’ will, contractually stipulated liquidated damages
must, as a rule,48 be maintained.
What respondent purports to be the ensuing nullification of liquidated
damages is not a novel question in jurisprudence. This matter has been
settled, and respondent’s position has been rebuked. In Laperal:
This notwithstanding, the Court does not agree with the Court of
Appeals that, as a consequence of the obligation of mutual restitution in
this case, petitioners should return the amount of P5,200,833.27 to
respondent.
Article 1191 states that “the injured party may choose between
fulfillment and rescission of the obligation, with the payment of damages in
either case.” In other words, while petitioners are indeed obliged to return
the said amount to respondent under Article 1385, assuming said figure is
correct, respondent is at the same time liable to petitioners in the same
amount as liquidated damages by virtue of the forfeiture/penalty clause as
freely stipulated upon by the parties in the Addendum, paragraphs 1 and 2
of which respectively read:
WHEREAS, included as part of said agreement are the following:
_______________
48  Subject to equitable reduction under Articles 1229 and 2227 of the
Civil Code.
 
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280 SUPREME COURT REPORTS ANNOTATED
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
1. Further to the stipulations on paragraph 10, upon default
of performances, violations and/or noncompliance with the
terms and conditions herein agreed upon by the DEVELOPER
wherein it appears that the DEVELOPER deliberately
abandoned or discontinued the work on the project, said
party shall lose any entitlement, if any, to any refund and/or
advances it may have incurred in connection with or relative
to previous development works in the subdivision; likewise,
all improvements of whatever nature and kind introduced by
the DEVELOPER on the property, existing as of the date of
default or violation, shall automatically belong to the OWNER
without obligation on his part to pay for the costs thereof.
 
2. Similarly with the same condition of default or violation
obtaining, as stated in paragraph 10 of said agreement, all
advances made and remittances of proceeds from
reservations and sales given by the DEVELOPER to the
OWNER as provided for in this agreement shall be deemed
absolutely forfeited in favor of the OWNER, resulting to waiver
of DEVELOPER’S rights, if any, with respect to said amount(s).
If this Court recognized the right of the parties to stipulate on an
extrajudicial rescission under Article 1191, there is no reason why this
Court will not allow the parties to stipulate on the matter of damages in
case of such rescission under Book IV, Title VIII, Chapter 3, Sec-
 
 
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Philippine Economic Zone Authority vs. Pilhino Sales Corporation
tion 2 of the Civil Code governing liquidated damages. 49 (Citations omitted)
 
We see no reason for departing from this. It is true that Laperal
involved extrajudicial rescission, while this case involves rescission through
judicial action. The distinction between judicial and extrajudicial rescission
is in how extrajudicial rescission is possible only when the contract has an
express stipulation to that effect. 50 This distinction does not diminish the
rights of a contracting party under Article 1191 of the Civil Code and is
immaterial for purposes of the availability of liquidated damages.
To sustain respondent’s claim would be to sustain an absurdity and an
injustice. Respondent’s position suggests that with rescission must
necessarily come the obliteration of the punitive consequence which, to
begin with, was the product of its own (along with the other contracting
party’s) volition. Its position turns delinquency into a profitable enterprise,
enabling contractual breach to itself be the means for evading its own
fallout. It is a position we cannot tolerate.
 
II
In calibrating the amount of liquidated damages, the Court of Appeals
relied on how respondent supposedly attempted to rectify things “by
offering to [petitioner] new specifications at P3,600,000.00 per unit; and
expressed willingness to shoulder the difference between the original price
(based on the contract) of P2,900,000.00 per unit and the price
corresponding to the new specifications.” 51
_______________
49  Laperal v. Solid Homes, Inc., supra note 46 at pp. 380-382; pp. 388-
390.
50  Alcaraz v. Tangga-an, 449 Phil. 62, 73; 401 SCRA 84, 92 (2003)
[Per J. Corona, Third Division]. See also Nissan Car Lease Philippines, Inc. v.
Lica Management, Inc., G.R. No. 176986, January 13, 2016, 780 SCRA 400
[Per J. Jardeleza, Third Division].
51  Rollo, p. 54.
 
 
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282 SUPREME COURT REPORTS ANNOTATED
Philippine Economic Zone Authority vs. Pilhino Sales Corporation
As underscored by petitioner, however, this offer was inconsequential
and hardly a remedy to the predicament it found itself in.
Petitioner already suffered damage by respondent’s mere delay.
Philippine Economic Zone Authority Director General Lilia B. De Lima’s
internal memorandum to its Board of Directors emphasized what was, at
the time, the specific urgency of obtaining fire trucks:
1. With the increase in the number of locator-enterprises at the regular
zones, there is a need for additional units of fire trucks to address any
eventuality. The onset of the El Niño phenomena further makes it
imperative that PEZA be more prepared.
2. At present, there are only six (6) units of serviceable fire trucks
distributed as follows:
Bataan EZ             2
Baguio City EZ      1
Cavite EZ              1
Mactan EZ            252  (Emphasis supplied)
The Court of Appeals itself recognized that “time was of the essence
when the contract . . . was awarded to [respondent] and the
noncompliance therewith exposed [petitioner’s] operations [at] risk.” 53
Respondent’s attempt at rectification came too late and under such
circumstances that petitioner was no longer even in a position to accept
respondent’s offer. As petitioner notes, by the time respondent made its
offer, the Complaint for rescission and damages had already been filed
before the Regional-Trial Court of Pasay City. 54 If at all, the offer was
nothing more than a belated reaction to undercut litigation.
_______________
52  Id., at p. 66.
53  Id., at p. 53.
54  Id., at p. 24.
 
 
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Philippine Economic Zone Authority vs. Pilhino Sales Corporation
By the time respondent made its attempt at rectification, petitioner was
no longer capable of accommodating contractual modifications.
Jurisprudence has established the impropriety of modifying awarded
contracts that were previously subjected to public bidding, such as that
between petitioner and respondent:
An essential element of a publicly bidded contract is that all bidders
must be on equal footing. Not simply in terms of application of the
procedural rules and regulations imposed by the relevant government
agency, but more importantly, on the contract bidded upon. Each bidder
must be able to bid on the same thing. The rationale is obvious. If the
winning bidder is allowed to later include or modify certain provisions in
the contract awarded such that the contract is altered in any material
respect, then the essence of fair competition in the public bidding is
destroyed. A public bidding would indeed be a farce if after the contract is
awarded, the winning bidder may modify the contract and include
provisions which are favorable to it that were not previously made
available to the other bidders. Thus:
It is inherent in public biddings that there shall be a fair
competition among the bidders. The specifications in such biddings
provide the common ground or basis for the bidders. The
specifications should, accordingly, operate equally or
indiscriminately upon all bidders.
The same rule was restated by Chief Justice Stuart of the Supreme
Court of Minnesota:
The law is well settled that where, as in this case, municipal
authorities can only let a contract for public work to the lowest
responsible bidder, the proposals and specifications therefore must
be so framed as to permit free and full competition. Nor can they
enter into a contract with the best bidder containing substantial
provisions beneficial to him, not
 
 
284
284 SUPREME COURT REPORTS ANNOTATED Petition granted, judgment and resolution reversed and set aside.

Philippine Economic Zone Authority vs. Pilhino Sales Corporation Notes.—A substantial breach of a reciprocal obligation like failure to
included or contemplated in the terms and specifications upon pay the price in the manner prescribed by the contract entitles the injured
which the bids were invited.55 (Emphasis supplied) party to rescind the obligation. (G.G. Sportswear Mfg. Corp. vs. World Class
Properties, Inc., 614 SCRA 75 [2010])
  A case for rescission or annulment of contract is not susceptible of
By definition, liquidated damages are a penalty, meant to impress upon pecuniary estimation although it may eventually result in the recovery of
defaulting obligors the graver consequences of their own culpability. real property; In determining whether an action is one the subject matter
Liquidated damages must necessarily make noncompliance more of which is not capable of pecuniary estimation, this Court has adopted the
cumbersome than compliance. Otherwise, contracts might as well make no criterion of first ascertaining the nature of the principal action or remedy
threat of a penalty at all: sought; Determination must be done on a case-to-case basis, depending
Liquidated damages are those that the parties agree to be paid in case on the facts and circumstances of each. (Home Guaranty Corporation vs.
of a breach. As worded, the amount agreed upon answers for damages R-II Builders, Inc., 652 SCRA 649 [2011])
suffered by the owner due to delays in the completion of the project. Under  
Philippine laws, these damages take the nature of penalties. A penal clause ——o0o——
is an accessory undertaking to assume greater liability in case of a breach.
It is attached to an obligation in order to ensure performance. 56 (Citations _______________
omitted)
** Designated Acting Chairperson per Special Order No. 2374 dated
  September 14, 2016.
Respondent cannot now balk at the natural result of its own breach. As
for the Court of Appeals, we find it to be in error in frustrating the express
terms of the contract that respondent actively endeavored to be awarded
to it. The exigencies that impelled petitioner to obtain fire trucks made it
imperative for respondent to act with dispatch. Instead, it dragged its feet,
left petitioner with inadequate means for addressing the very emergencies
that engendered the need for fire trucks, and forced it into litigation to
enforce its rights.
WHEREFORE, the Petition is GRANTED. The assailed May 2, 2008
Decision and November 25, 2008 Resolution of
_______________

55  Agan, Jr. v. Philippine International Air Terminals Co., Inc., 450 Phil.
744, 814-815; 402 SCRA 612, 654-655 (2003) [Per J. Puno, En Banc].
56  H.L. Carlos Construction, Inc. v. Marina Properties Corp., 466 Phil.
182, 205; 421 SCRA 428, 445 (2004) [Per J. Panganiban, First Division].

 
 
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Philippine Economic Zone Authority vs. Pilhino Sales Corporation
the Court of Appeals in C.A.-G.R. CV No. 86406 are REVERSED and SET
ASIDE. The Decision dated November 2, 2005 of Branch 108 of the
Regional Trial Court of Pasay City in Civil Case No. 00-0343
is REINSTATED.
SO ORDERED.
Brion** (Acting Chairperson), Del Castillo and Mendoza, JJ., concur.
Carpio, J., On Official Leave.