MODULE XIII

COMPENSATION
(Arts. 1278 – 1290)

COMPENSATION, CONCEPT

Compensation shall take place when two persons, in their own right, are
creditors and debtors of each other (Art. 1278). It is a mode of extinguishing
obligations whereby two persons in their capacity as principals are mutual
debtors and creditors of each other with respect to equally liquidated and
demandable obligations to which no retention or controversy has been timely
commenced and communicated by third parties.

Example: D owes C P5, 000.00. C owes D P5, 000.00. Both debts are due
and demandable. The parties do not need to pay each other as their obligations
are extinguished by compensation.

KINDS OF COMPENSATION

1. As to amount extent

A. Total – when the debts are of the same amount (Art.1281); and
B. Partial – when the debts are of different amounts (Art.1281).

2. As to cause or origin

A. Legal – this takes place by operation of law and extinguishes both

debts to the concurrent amount (Art.1279) even though the debts are payable
at different places (Art.1286) and the creditors and debtors are not aware of
the compensation. (Art.1290). Legal compensation operates even against the
will of the interested parties and even without their consent. Such
compensation takes effect ipso jure (which means ‘by the law itself’); its effects
arise on the very day on which all the requisites concur. See the discussion
below for the requisites and examples.
 B. Voluntary or conventional– when it takes place by agreement of the
parties (Art. 1282).

Example:

D owes C P5, 000 due on September 20, 2015, C owes D P5, 000 due on
September 30, 2015. On September 1, 2015, for instance, D and C may agree
that their debts be compensated.

Note that parties may agree upon the compensation of debts which are
not yet due (Art. 1282).

C. Judicial (set-off) – when it takes place by order from a court in a

litigation. If one of the parties to a suit over an obligation has a claim for
damages against the other, the former may set it off by providing his right to
said damages and the amount thereof (Art. 1283).

Example:

T, a travel agent, sued P for collection of P10, 000 representing the

balance of P for a guided tour in Bangkok which T arranged. In his answer, P
claimed that T owed him damages amounting to P10, 000.00 which he (P) and
his family sustained as a result of the substandard hotel accommodations that
T booked for them. P was able to prove his right to said damages and the
amount thereof. Any compensation declared by the court in this case is one of
judicial compensation.

D. Facultative – this is a compensation that may be claimed or

opposed by one of the parties (such as when not all the requisites for legal
compensation are present.

Example:

D owes C P5, 000 which is due and payable on September 1, 2015, while
C owes D P5, 000 which is due and payable on or before September 30, 2015.
On September 1, 2015, C may claim compensation because he was given the
benefit of the period, i.e., he may choose to pay on or before September 30,
2015. Should D claim compensation on September 1, 2015, C have the right to
oppose it because he cannot be compelled, although he may opt to pay, before
September 30, 2015. See the discussion below for further examples of a
facultative compensation.

REQUISITES OF LEGAL COMPENSATION (Art. 1279)

1. That parties are principal creditors and principal debtors of each

other.

Examples:

A. D owes C P5,000.00. C owes D P5, 000.00. Legal compensation

takes place because D and C are principal debtors and creditors of each other.

B. D owes C P5, 000.00 with G as guarantor. C owes G P5,000. Legal

compensation may not take place between D and C because while D is a
principal debtor of C, C is not even a debtor of D. Legal compensation may not
take place between G and C because although C is a principal debtor of
G, G is only a subsidiary debtor of C. Exception to B is Article 1280.

A guarantor may set up compensation as regards what the creditor may

owe the principal debtor (Art.1280).

Example:

D owes C P5, 000.00 with G as guarantor. C owes D P4, 000.00. On due

date, C demands payment from D but D no longer has any assets so C goes
after G. G may set up compensation up to P4,000.00 so C can collect from him
P1,000.00 only.

2. That both debts consist in a sum of money or if the things due are
consumable, they be of the same kind, and also of the same quality if the latter
has been stated.

Examples:

(A) A owes B P1,000.

B owes A an electric range worth P1,000.
Here, no compensation will take place.
 (B) A obliged himself to deliver to B 10 sacks of rice while B obliged
himself to deliver to A 10 sacks of corn.
Compensation will not also take place because the things due are
not of the same kind.

(C) A owes B any horse.

B owes A any horse.
Compensation will take place in tis case, although the things due
are not consumable since the things due are of the same kind.

3. That the two debts be due or demandable. That is, the maturity
date of both debts must have arrived for legal compensation to take place.
Here, it is not required that both debts have the same due date.

Examples:

(A) A owes B P1,000 due yesterday.

B owes A P1,000 due today.
The two debts may be compensated because they are both due and
demandable.

(B) A owes B P1,000 due today,

B owes A P1,000 due next month.
Compensation cannot take place as one of the debts is not yet due.

4. That both debts be liquidated. “Liquidated” means the amount of

the debts has already been determined or is easily determinable. On the
other hand, “demandable” means both debts must be enforceable, so if one of
them has prescribed, legal compensation cannot take place.

Examples:

A owes B P1,000.
B owes A the share of the latter in a business the amount of which
is still to be ascertained.
Compensation will not take place as the debt of B is not liquidated.

5. No retention or controversy commenced by a third person.

 Example:

D owes C P10, 000.

C owes D P10, 000.
C also owes X P10, 000.
X sues C and asks the court to order D not to pay C so that in the
event the court renders judgment in favor of X, D will have to pay X. The
court issues the order to D. There can be no legal compensation between
D and C because there is an order of retention to D with respect to his
debt to C (See Art. 1243).

INSTANCES OF FACULTATIVE COMPENSATION

1. When one of the debts arises from a deposit (Art 1287). A deposit is a
contract where a person receives a thing belonging to another for safely
keeping it and of returning the same (Art. 1962). The depositor may claim
compensation, or oppose one that is being claimed by the depositary. The
deposit referred to here is different from a bank deposit which is actually a
contract of loan. In a bank deposit, the bank and its client have a debtor-
creditor relationship. Either one therefore may claim compensation.

Example:

C is the depositary of D’s ring. Previously, D made a promise to give a

ring to C. If D demands the return of the ring he deposits C, C cannot refuse to
return it by claiming that D owes him a ring. However, if C demands the
delivery of a ring from D as D had promised, D may, at his option, set off the
claim of C against his own claim for the return of the ring he deposited with C.

2. When one of the debts arises from the obligations of a bailee in a

commodatum (Art. 1287). Commodatum is a contract whereby the bailee
acquires the use without compensation of the thing loaned but not its fruits
(Art. 1935). Here, the lender may claim compensation, or oppose one that is
being claimed by the borrower.

Example:
 C borrowed D’s bicycle. D has a promise to give a bicycle to C. if D
demands the return of the bicycle he lent C, C cannot refuse to return it by
claiming that D owes him a bicycle. However, if C demands the delivery of a
bicycle from D as D had promised, D may, at his option, set off the claim of C
against his own claim for the return of the bicycle that he loaned to C.

3. When one of the debts arises from a claim for support by gratuitous
title (Art. 1287). The support referred to here is future support, not support in
arrears (Art. 301). The party entitled to receive support may claim
compensation, or oppose one that is being claimed by the party required to give
support.

Examples:

H, husband, was ordered by the court in a case of legal separation to give

a monthly support of P20, 000 to W, his wife. H has not yet given the amount
to W for the present month. On the other hand, W owes H P20, 000.00 by way
of loan. W may claim compensation but not H.

B is the father of A, a minor, who under the law is entitled to be

supported by B. now A owes B P1,000. B cannot compensate his obligation to
support A by what A owes him because the right to receive support can not be
compensated with what the recipient A owes the obligor B. the right to receive
support cannot be compensated because it is essential to the life of the
recipient. However, if B failed to support A, say for the past three months, the
support in arrears may be compensated with the debt of A. The reason is that
A no longer needs the support in arrears as he was able to exist even without
the support of B.

4. When one of the debts consists in civil liability arising from a penal
offense (Art. 1288). Here, the offended party may claim compensation but not
the offender.

Example:

D owes C P50, 000 by way of loan. One day, C intentionally rammed his
jeep on the fence of D, causing damages thereon amounting to P50, 000. C was
charged and convicted of the crime of malicious mischief. He was ordered to
pay D P50, 000 for the damages on the fence. If D demands the payment of
such damages, C cannot claim compensation on the ground that D owes him
P50, 000 by way of loan. However, if C demands the payment of the loan from
him, D may claim the compensation by offsetting it against his claim for
damages against C.

COMPENSATION WHEN ONE OR BOTH DEBTS ARE RESCISSIBLE OR

VOIDABLE

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).

Example:

D owes C P1,000. Subsequently, D, through fraud, was able to make C

sign a promissory note that C is indebted to D for the same amount.

The debt of D is valid but that of C is voidable. Before the debt of C is

nullified, both debts may be compensated against each other if all the
requisites for legal compensation are present.

Suppose C’s debt is later on annulled by the court, is D still liable

considering that compensation had already taken place? Yes. The effect of the
annulment is retroactive. It is the same as if there had been no compensation.

COMPENSATION WHEN DEBTS ARE PAYABLE AT DIFFERENT PLACES

Compensation takes place by operation of law, even though the debts

may be payable at different places, but there shall be an indemnity for
expenses of exchange or transportation to the place of payment (Art. 1286).

Examples:

1. A owes B 1,000 US Dollars payable in New York. B owes A P51,000

(equivalent amount) payable in Manila.
If A claims compensation, he must pay for the expenses of exchange.

2. A obliged himself to deliver to B 500 sacks of rice in Davao. B is

also bound to deliver to A 100 sacks of rice of the same kind in Bulacan. The
expenses for transportation of the rice to Davao amount to P4,000 and to
Bulacan, P1,000.

If A claims compensation, he must indemnify B the amount of P3,000 for

the expenses of transportation of rice to Davao.

RULE ON APPLICATION OF PAYMENT TO APPLY WHEN THERE ARE

SEVERAL DEBTS SUSCEPTIBLE OF COMPENSATION (Art. 1289)

Compensation is similar to payment. If a debtor has various debts which

are susceptible of compensation, he must inform the creditor which of them
shall be the object of compensation. In case he fails to do so, then the
compensation shall be applied to the most onerous obligation.

Example:

A is indebted to B in the amount of:

1. P1,000 without interest due today;

2. P1,000 with interest of 18% due also today; and
3. P1,000 with interest at 16% due yesterday.

B owes A P1,000 due today.

For purposes of the application of payment, A is the debtor. He

must specify to B which of the three debts should be compensated. If e fails to
inform B, then the latter should apply the compensation to the second
obligation of A, namely, the obligation bearing the 18% interest because it is
the most onerous obligation.

EFFECT OF ASSIGNMENT ON COMPENSATION OF DEBTS

1. When the assignment was with the debtor’s consent, he cannot set up
against the assignee the compensation that would pertain to him against the
assigner unless he reserved his right to the compensation.

Example:

D owes C P20, 000 due on March 15.

C owes D P8, 000 due on March 10.
On March 12, C assigned his credit right to T with the consent of D.
 On March 15, T can collect from D P20, 000 but D can collect P8, 000
from C. If D reserved his right to the compensation that would pertain to him
against C amounting to P8, 000 when he consented to the assignment, then T
can collect only P12, 000 from D.

2. If the debtor was notified of the assignment but he did not give his
consent thereto, debtor may set up compensation of debts maturing before the
assignment but not of subsequent ones.

Example:

D owes C P20, 000 due on March 15.

C, on the other hand, owes D the following debts: P8, 000 due on March
1; P3, 000 due on March 8; and P5, 000 due on March 14.
On March 12, C assigned his credit right to T with notice to D but D did
not give his consent to the assignment.
In this case, T may collect from D P9, 000 because D can set up
compensation with respect to the debts due on March 1 (P8, 000) and March 8
(P3, 000) which had already matured at the time of the assignment.

3. If the assignment was without knowledge of the debtor, he can set up

compensation of all debts maturing before the time he obtains knowledge of the
assignment.

Example:

D owes C P20, 000 due on March 25.

C, on the other hand, owes D the following debts: P8, 000 due on March
1; P3, 000 due on March 8; P5, 000 due on March 14, and P2, 000 due on
March 31.
On March 12, C assigned his credit right to T without the knowledge of
D. On March 16, D learned of the assignment.
In this case, T may collect from D P4, 000 because D may set up
compensation with respect to the debts due on March 1 (P8,000), March 8
(P3,000), and March 14 (P5,000), which debts have become due as of March 16
when D learned of the assignment.
COMPENSATION IN SOLIDARY OBLIGATION

A is indebted to X, Y and Z, solidary creditors, for P30, 000 due on June

1, 2015. X in turn owes A P30, 000.00 due on June 1, 2015. Both obligations
being due, they are extinguished by compensation. However, X has to give Y
and Z their respective shares at P10, 000.00 each because compensation made
by any of the solidary creditors shall render him liable to the others for the
share in the obligation corresponding to them (See Art. 1215).