MODES OF EXTINGUISHING OBLIGATIONS:

OUTLINE NOTES
LAW 121/OBLIGATIONS & CONTRACTS
SECTIONS JD1A & JD1B
By: JEN N. ASUNCION

CONFUSION OR MERGER OF RIGHTS

A. CONCEPT

1. The obligation is extinguished from the time the characters of creditor and
debtor are merged in the same person. (Art. 1275, NCC). The debtor is his own
creditor.

RATIONALE: The obligation becomes absurd, since one cannot claim against
himself.

2. Confusion or merger usually takes place when the debtor acquires the credit.

Example: A borrowed P100,000.00 from his father, who

subsequently died and left A as his sole heir. A thus
succeeded his father’s credit of P100,000.00 against A.
Thus, as far as the P100,000.00 is concerned, the
characters of creditor and debtor have become
merged in the person of A.

3. Confusion or merger may also take place when the creditor acquires an
encumbered property.

Example: When the mortgagee acquires the

mortgaged property, the mortgage obligation is
extinguished (but not necessarily the principal
obligation secured by the mortgage)

4. REQUISITES:

a. The merger of the characters of the creditor and debtor must be in the
same person;

b. The merger must take place in the person of either the principal creditor or
the principal debtor; and,

c. The merger must be complete and definite.

B. EFFECT AND EXTENT

1. Confusion or merger which takes place in the person of the principal creditor
or debtor benefits the guarantors. (Art. 1276, NCC)

a. But a merger which takes place in the person of any of the guarantors does
not extinguish the obligation.

Example: A is indebted to B, which debt is guaranteed

by C. If A’s debt to B is extinguished due to merger, C’s
obligation as guarantor (which is merely accessory) is
also extinguished. But if C acquires B’s credit thereby
extinguishing C’s obligation as guarantor, this does not
affect A’s obligation. C can still collect from A.
 2. Confusion does not extinguish a joint obligation except as regards the share
corresponding to the creditor or debtor in whom the two characters concur.
(Art. 1277, NCC)

Example: A & B (joint debtors) are indebted to C in the

amount of P300,000.00. A and B issued a promissory
note. C is indebted to D and negotiated to him the
same PN. D is indebted to E and negotiated the same
PN. E is indebted to B and negotiated the same PN.
There is merger but only up to the share that
corresponds to B which is P150,000.00.

3. If the obligation is solidary, it may be extinguished by the confusion or merger

between any of the creditors with any of the debtors, subject to
reimbursement,

Example: In the above example but A and B are

solidary debtors, the entire debt is extinguished but
subject to reimbursement from A.

COMPENSATION

A. IN GENERAL

1. DEFINITION. Compensation (or OFFSETTING) is a mode of extinguishing (to the

concurrent amount) the obligations of persons, who in their own right and as
principals, and reciprocally debtors and creditors of each other. (Art. 1278,
NCC)

2. Confusion v. Compensation:

COMPENSATION CONFUSION
Two persons, who in their own right, One person, in whom is merged the
are creditors and debtors of each qualities of a creditor and debtor
other
There must be at least two debts There is only one obligation

3. KINDS OF COMPENSATION

a. AS TO CAUSE:

o LEGAL COMPENSATION – takes effect by operation of law (ipso jure)

from the moment all the requisites prescribed by law are present (Art.
1279, NCC)

o VOLUNTARY OR CONVENTIONAL COMPENSATION – By agreement of

the parties. The parties agree to the mutual extinguishment of their
mutual obligations in the absence of some of the legal requisites.

o JUDICIAL COMPENSATION – Takes effect by judicial decree

o FACULTATIVE COMPENSATION – When the compensation can be set

up only by one of the parties.

Example:

A is indebted to B in the amount of P300,000.00 due on April 29, 2020

 B is indebted to A in the amount of P300,000.00 due on or before May
1, 2020

On April 29, 2020, B can claim compensation because he has the

benefit of the period. A cannot claim or set-up compensation
because the period is not yet due.

b. AS TO EFFECT

o TOTAL COMPENSATION – When the two debts are of the same

amount.

o PARTIAL COMPENSATION – When the two debts are not of the same
amount.

B. LEGAL COMPENSATION

1. IN GENERAL. Legal compensation takes place by operation of law (ipso jure)

when all the requisites are present. It occurs EVEN WITHOUT AWARENESS OF THE
PARTIES. (Art. 1290, NCC) or even AGAINST THEIR WILL or WITHOUT CONSENT. Its
effects arise at the moment when all the requisites concur. (Republic v. CA,
G.R No. 25012, July 22, 1975)

2. REQUISITES: In order that legal compensation may be proper, the following five
(5) requisites are necessary:

(a) THAT EACH OF THE OBLIGORS BE BOUND PRINCIPALLY, AND THAT HE BE AT

THE SAME TIME A PRINCIPAL CREDITOR OF THE OTHER;

NB: The parties must be mutually debtors and creditors in their own right and
as principals.

(1) Thus, JEN Corporation’s debt to A cannot be offset with A’s debt to a
stockholder of JEN Corporation, because the corporation is distinct from
its stockholder (CKH Industrial and Dev’t. Corp. v. CA, GR No. 111890,
May 7, 1997)

(2) The debt of partnership JEN to A cannot be offset with A’s debt to J (a
partner of JEN)

(3) Taxes cannot be compensated with the taxpayer’s claim against the
Government, because taxes are not “debts” and the Government, and
the taxpayer cannot be considered creditor and debtor to each other.
(Francia v. IAC, GR No. L-67649, June 28, 1988)

(b) THAT BOTH DEBST CONSIST IN A SUM OF MONEY, OR IF THE THINGS DUE ARE
CONSUMABLE, THEY BE OF THE SAME KIND, AND ALSO OF THE SAME QUALITY
IF THE LATTER HAS BEEN STATED;

NB: Compensation is also possible for fungible things (not necessarily

consumable) because, by their very nature, fungible things may be
substituted for each other.

(c) THAT THE TWO DEBTS MUST BE DUE AND DEMANDABLE

DUE – The period has arrived, or the condition has been fulfilled.
DEMANDABLE – Debts have not prescribed or declared invalid or illegal.
 (d) THE TWO DEBTS ARE LIQUIDATED

LIQUIDATED – means that the existence and amount of the debt are
determined, as opposed to unliquidated claims (such as damages) which
are still disputed and whose amount is not yet determined. Compensation
cannot extend to unliquidated, disputed claim existing from breach of
contract.

NB: When one or both debts are rescissible or voidable, they may be
compensated against each other before they are judicially rescinded or
avoided. (Art. 1284, NCC). They are considered valid until annulled or
rescinded.

NB: Legal compensation is possible even though the debts may be payable
at different places, but there shall be an indemnity for expenses of
exchange or transportation to the place of payment. (Art. 1286, NCC)

(e) THAT OVER NEITHER OF THEM THERE BE ANY RETENTION OR CONTROVERSY,

COMMENCED BY THIRD PERSONS AND COMMUNICATED IN DUE TIME TO THE
DEBTOR.

Example: When a credit is garnished by the court

(execution or attachment)

3. WHO MAY INVOKE. Generally, compensation may be invoked or claimed by

the principal debtor (who is also at the same time a principal creditor).

HOWEVER, the guarantor may also set up compensation as regards what the
creditor may owe the principal debtor. (Art. 1280, NCC) That is, the guarantor
may invoke any available compensation between the principals, and thus
benefit from the extinguishment of the principal obligation which results from
such compensation.

4. ASSIGNMENT OF CREDIT. In case the creditor assigned his credit to a third party,
who then attempts to enforce it, the debtor has the following rights:

a. IF COMPENSATION HAS ALREADY TAKEN PLACE BEFORE THE ASSIGNMENT –

the obligation is deemed extinguished by operation of law, and the debtor
is thus discharged of liability by invoking the compensation.

Exception: If the debtor CONSENTED to the assignment, this is considered a

WAIVER of the compensation.

b. IF COMPENSATION HAS NOT YET TAKEN PLACE BEFORE THE ASSIGNMENT

(e.g., the debts are not yet mature or liquidated) –

(1) If the debtor consented – he cannot set up against the assignee the
compensation which would pertain to him against the assignor. (Art.
1285, NCC)

- Unless the assignor was notified by the debtor at the time he gave
his consent, that he reserved his right to the compensation. (Art.
1285, NCC)

(2) If the debtor was informed of the assignment, but did not consent thereto
– he may set up the compensation of debts before the assignment, but
not of subsequent ones. (Art. 1285, NCC)
 (3) If the debtor was not informed of the assignment – he may set up the
compensation of all credits prior to the assignment and also later ones
until he had knowledge of the assignment. (Art. 1285, NCC)

NOTE: The reason for the foregoing rules is to protect a party from being
fraudulently deprived of the benefits of compensation.

5. PLURALITY OF DEBTS. If a person should have against him several debts which
are susceptible of compensation, the rules on the application of payments
shall apply to the order of the compensation. (Art. 1289, NCC)

- Thus, the debt which is most onerous to the debtor, among those
due, shall be deemed to have been offset. If the debts due are of
the same nature and burden, the offsetting shall be applied to all of
them proportionately. (Art. 1289 in rel. to Art. 1253, NCC)

6. EFFECT OF LEGAL COMPENSATION. When all the requisites mentioned in Art.

1279, NCC are present, compensation takes effect by operation of law, and
extinguishes both debts to the concurrent amount, even though the creditors
and debtors are not aware of the compensation. (Art. 1290, NCC)

C. CONVENTIONAL COMPENSATION

1. IN GENERAL. Conventional or voluntary compensation is compensation by

agreement; it takes place when the parties agree to compensate their mutual
obligations even in the absence of some requisites.

- Thus, the parties may agree upon the compensation of debts which
are not yet due

2. REQUISITES. Conventional compensation is possible only when the parties are

mutual creditors and debtors of each other. Aside from this, the requirements
of conventional compensation are:

(a) That each of the parties can dispose of the credit he seeks to compensate,
and,

(b) That they agree to the mutual extinguishment of their credits.

D. LIMITATIONS: The following debts cannot be compensated. (Art. 1287, NCC) –

1. Debts arising from a contract of depositum; (Art. 1962, NCC)

2. Debts arising from a contract of commodatum;

a. Both depositum and commodatum are based on the trust and confidence
of the depositor or bailor that the thing deposited or lent will be returned.

b. The prohibition is against the depositary and the borrower, in favor of the
depositor and bailor. The depositor and bailor may choose to waive the
benefit and set up compensation (facultative)

c. Note that bank deposits (whether fixed, savings or current deposits) are
considered simple loans (Art. 1980, NCC), and are therefore subject to
compensation or set-off against the depositor’s obligation to the bank.
(Spouses Nisce v. Equitable PCI Bank, GR No. 167434, February 19, 2007)

3. Claims for support due by gratuitous title; (Art. 1287, NCC)

 a. Allowing compensation may defeat the purpose of support, which is to
maintain the person to be supported and answer his needs. It may also
defeat the exemption of support from attachment and execution. (Art. 205,
FC)

b. Support in arrears may be subject to compensation, because the need for

the same has already passed. (Art. 301, par. 2 in rel. to Art. 1287, NCC)

4. Debts consisting of civil liability arising from a penal offense. (Art. 1288, NCC)

- The prohibition is against the offender, in favor of the offended party.

The offended party may choose to waive the benefit and set up
compensation (facultative)

5. Obligation to pay taxes to the government. Taxes are not debts and are not
subject to compensation as a matter of public policy.