G.R. No. 254510, June 16, 2021 (Art.
(Art. 1216, 1217, 1219, 1226, 1229) Undertaking" on July 27, 2001 in favor of FMLFC. More, on November 29, 2002, one
MERRIE ANNE TAN, Petitioner, v. FIRST MALAYAN LEASING AND FINANCE CORP.,
NEW UNITEDWARE MARKETING CORP., AND EDWARD YAO, Respondents.
This is a Petition for Review on Certiorari1 (Petition) under Rule 45 which seeks a reversal
of the October 30, 2019 Decision2 and the November 24, 2020 Resolution3 of the Court of
Appeals Former Special Fourth Division (CA) in CA-G.R. CV No. 110069, and prays for the
following reliefs:
WHEREFORE, it is most respectfully prayed of the Honorable Supreme Court that:
1. Instant petition, primarily a plea and cry for true justice, be given due course;
2. The Decision dated October 30, 2019 and Resolution dated November 24, 2020 of the
Court of Appeals in CA-GR CV No. 110069 be reversed and set aside;
3. A new decision be rendered as follows:
3.1. Ordering respondent Yao to pay the entire claim of the respondent (plaintiff-appellee)
[FMLFC];
3.2. Deleting the award for penalty of 12% per annum starting November 17, 2004 until
full payment and the 10% percent attorney's fees;
3.3. Ordering respondent Yao to pay damages and attorney's fees to respondent NUMC
and the petitioner and her husband;
Granting unto petitioner such other reliefs just and equitable under the premises. 4
Facts
The factual backdrop of the instant controversy is straightforward, and involves the
primary issue of the status and nature of the obligation of the remaining multi-party
surety on a defaulted loan payment, upon the release of one of the sureties.
On December 8, 2000, respondent New Unitedware Marketing Corporation (NUMC)
obtained a loan from respondent First Malayan Leasing and Finance Corporation (FMLFC)
in the amount of P5,000,000.00, as evidenced by the terms of the Promissory Note
executed on even date. The loan was later refinanced on various dates at the instance of
NUMC.5 As security for the loan, NUMC executed a Deed of Assignment on July 2, 2001 in
favor of FMLFC, covering NUMC's fire insurance claim proceeds from Philippine Charter
Insurance Corporation (PCIC). Furthermore, as additional security, petitioner Merrie Anne
L. Tan (Merrie Tan), who was a member of NUMC's Board of Directors, and Edward Yao
(Yao), as President and General Manager of NUMC,6 executed a "Continuing Surety
Samson Ding (Ding), also a member of NUMC's Board of Directors, and Merrie Tan's
spouse, Willy Tan (now deceased) likewise executed a second Continuing Surety
Undertaking in favor of FMLFC.
When NUMC defaulted on its payment of the loan, FMLFC declared that as of November
17, 2004, NUMC owed it the remaining balance of P2,942,822.36 due, exclusive of 5%
penalty charges and interests.7 When FMLFC's demands on NUMC, as well as on Yao, Ding
and Spouses Merrie and Willy Tan (Spouses Tan) went unheeded, it filed a Complaint for
Sum of Money and Damages with Prayer for Preliminary Attachment on January 3, 2005
against NUMC, Ding and Spouses Tan before Branch 62, Regional Trial Court, Makati City
(RTC) docketed as Civil Case No. 04-1384.8
Then on October 21, 2005, during the pendency of the proceedings before the RTC, Merrie
Tan discovered that Ding, in behalf of another corporation, and Yao, in behalf of NUM, had
entered into a Compromise Agreement with PCIC, where Ding and Yao were paid the
amounts of P55,570,930.92 and P75,867,556.73, respectively, as payments for the fire
insurance policy claim, the proceeds of which were earlier assigned by NUMC in favor of
FMLFC.9
Premised on the said Compromise Agreement, Merrie Tan argued that Ding and Yao
should be made exclusively liable for FMLFC's claim since they were the ones who received
the proceeds from the fire insurance claim, which was intended to pay for the outstanding
loan obligation of NUM to FMLFC.10
Yao, for his part, denied that he received the proceeds of the fire insurance claim from
PCIC, and contended that the indemnity checks which PCIC paid were merely endorsed by
him in his official capacity to the bank for encashment, but that the proceeds of the checks
were delivered by the bank to Ding and Willy Tan. Yao finally added that he already settled
with FMLFC his share of NUMC's obligation when he paid FMLFC the amount of
P980,000.00, in exchange of which the latter executed a "Receipt and Release" in his
favour.11
RTC Ruling
On February 9, 2017, the RTC rendered its Decision which ruled for FMLFC, with its
dispositive portion reading thus:
WHEREFORE, judgment is hereby rendered in favor [of] plaintiff FIRST MALAYAN LEASING
AND FINANCE CORPORATION ordering the defendants NEW UNITEDWARE MARKETING
CORPORATION, MERRIE ANNE L. TAN, SING JIAN ZI aka SAMSON DING and CHEN YI
MING aka WILLY TAN to pay the former, jointly and solidarily, the following:
1. Two Million Nine Hundred Forty-Two Thousand Eight Hundred Twenty-Two & Thirty-Six Centavos
(Php2,942,822.36) Philippine currency p[l]us interest at the legal rate of six (6%) percent per annum as
well as penalty charge at the rate of twelve (12%) percent per annum reckoning from November 17, 2004
 until fully paid;
� �
2. Amount equivalent to ten (10%) percent of the total amount due as liquidated damages;
� �
3. Amount equivalent to ten (10%) percent of the total amount due as and for attorney's fees; and
� �
4. Costs of litigation.
The Third-Party Complaint filed by Merrie Anne Tan and Willy Tan is hereby DISMISSED.
SO ORDERED.12
In ruling in favor of FMLFC, the RTC held that Spouses Tan, Ding and Yao are indeed
solidarily liable under the "Continuing Surety Undertaking each had executed, and that
Yao's release as executed by FMLFC did not operate to absolve Spouses Tan and Ding as
co-sureties from their solidary liability on the loan obligation of NUMC. It held that Yao's
release only extinguished FMLFC's claim against him, but did not affect the former's claim
against the co-sureties.13 It also rejected Merrie Tan's third-party claim that Yao should be
held to account for the insurance proceeds from PCIC, as the same was not included in
FMLFC's claim against them and that the docket fees for said complaint were not
paid.14 The RTC, however, adjusted the rates of stipulated interests which it found
iniquitous and unconscionable.
Spouses Tan filed an Omnibus Motion for New Trial/Reconsideration on June 28, 2017,
which was similarly denied by the RTC through its Order dated September 5,
2017.15 Spouses Tan thereafter appealed to the CA, with the same docketed as CA-G.R.
CV No. 110069.
CA Ruling
The CA denied Spouses Tan's appeal through its Decision dated October 30, 2019, which
dispositively read:
WHEREFORE, the appeal is DENIED. The Decision dated February 9, 2017
and Order dated October 6, 2017 of the Regional Trial Court of Makati City, Branch 62, in
Civil Case No. 04-1384, are hereby AFFIRMED with the MODIFICATIONS that:
(1) the interest rate is reduced to twelve percent (12%) per annum from November 17, 2004 until June 30,
2013 and six percent (6%) per annum from July 1, 2013 until the finality of this decision;
� �
(2) the penalty charge imposed is reduced to six percent (6%) per annum reckoned from November 14, 2004;
and
� �
(3) the total judgment award shall be subject to interest at the rate of six percent (6%) per annum from the
finality of this Decision until is full satisfaction.
The rest of the RTC's Decision stands.
SO ORDERED.16
Therein, the CA found that: (i) the release of Yao as co-surety did not extinguish the
remaining co-sureties' solidary liability;17 (ii) the simultaneous imposition of penalty
charges, liquidated damages and attorney's fees is proper but the reduction of the said
rates is warranted;18 and (iii) the third-party complaint filed by Spouses Tan against Yao
was correctly dismissed since no docket fees were paid therefor. 19
First, the CA ruled that contrary to Merrie Tan's claim that the release of Yao as surety
effectively novated the solidary obligation to a divisible one, the release of Yao only had
the effect of a modificatory novation, since FMLFC nevertheless retained its right to pursue
the old obligation on the remaining sureties.20 It held that the loan balance over which the
remaining sureties were solidarily liable was only reduced from P3,429,813.58 to
P2,942,822.36, upon the deduction of Yao's payment of P980,000.00.21
Second, it found that the Promissory Note stipulated two penalty clauses: (i) the late
payment charge of 5% per month, and (ii) 25% of the total amount due for attorney's
fees and 25% of the total amount due as liquidated damages. The CA reasoned that the
late payment charge, liquidated damages and attorney's fees constitute free and voluntary
stipulations which are well-within the parties' prerogative to secure performance and
discourage breach.22 It added that there was nothing improper in the stipulation of
attorney's fees since they are similarly imposed as a penalty for breach of an obligation. 23
xxx
Spouses Tan sought a reconsideration xxx denied xxx Merrie Tan resorted to this
Court via the instant Petition.
In the instant Petition, Merrie Tan submits that the CA erred in holding that her solidary
obligation along with Ding and her husband, Willy Tan was not novated to a divisible
obligation by virtue of FMLFC's release of Yao upon the latter's payment of his share
alone.26 She likewise argues that the CA erred in ordering the payment of the rate of
6% per annum legal interest and the rate of 12% per annum penalty charge, and that it
also erred in ordering the simultaneous payment of 10% of the total amount for liquidated
damages and 10% of the total amount for attorney's fees. Finally, she prays that the
Court reverses the CA's affirmation of the RTC's dismissal of her third-party complaint
against Yao.27
Merrie Tan first argues that when FMLFC released Yao from the solidary surety obligation
upon the latter' partial payment of the entire loan obligation, it effectively converted the
solidary obligation to a divisible one, where the co-sureties are no longer liable for the
whole obligation but only for their respective shares therein. 28 She avers that otherwise, it
would be the height of injustice if Yao was only held liable for the amount of P980,000.00
while respondent NUMC, Ding and herself are still held liable for the total outstanding loan
obligation of P2,942,822.36. She adds that FMLFC is already stopped from claiming that
the obligation of the sureties is still solidary, when it already accepted Yao's partial
payment and released him by virtue of the same, with Yao's payment effectively being far
below the amount of the total loan obligation.29
On the matter of the simultaneous imposition of penalty and liquidated damages, she
avers that since both are of a similar nature, the award of one precludes the award of the
other.30
With respect to the dismissal of her third-party complaint against Yao, Merrie Tan submits
that instead of dismissing her complaint, the RTC should have instead ordered her and her
husband to pay the docket fee pursuant to Section 7, Rule 141 of the Rules of Court. 31
Finally, with respect to Yao's liability, Merrie Tan maintains that as a signatory to the Deed
of Assignment of the fire insurance claim proceeds, Yao is primarily liable to ensure that
the claim of FMLFC is settled through the payment of NUMC's fire insurance claim
proceeds. She asserts that Yao's failure to ensure payment of said claim by FMLFC
indicates gross negligence and breach of duties and obligations of Yao as the President and
General Manager of NUMC.32 She adds that NUMC was not made aware of the settlement
with PCIC, and that the same was only discovered when FMLFC filed a garnishment case
against PCIC, and PCIC intimated that it had already earlier paid NUMC's claim in full
through Yao.33
Issue
The threshold issue for the Court's resolution is whether the CA erred in affirming the RTC
in the following findings: (i) the solidary obligation insofar as Spouses Tan and Ding were
concerned was not novated by FMLFC's release of Yao; (ii) the penalty charges, liquidated
damages and attorney's fees were properly imposed; and (iii) the third-party complaint of
Spouses Tan against Yao was correctly dismissed.
The Court's Ruling
The Court finds the Petition partly meritorious.
Specifically, the Court rules that the CA correctly held that the obligation of the Spouses
Tan and Ding remain solidary despite the release of Yao from the same, but it erred in
affirming the RTC's simultaneous imposition of the penalty charge and the liquidated
damages, its imposed rate of attorney's fees, and its dismissal of Merrie Tan's third-party
complaint against Yao with prejudice.
Preliminarily, the Court notes the importance of the autonomous characteristic of
contracts, pursuant to which the parties are free to establish such stipulations, clauses and
other terms and conditions as they may agree upon to be convenient, with the only
parameter that they are not contrary to law, morals, good customs, public order or public
policy.34 It is further remembered that when the terms of an agreement have been
reduced to writing, it is considered as containing all the terms agreed upon and there can
be no evidence on such terms other than the contents of the written agreement.35 Finally,
when the terms of the contract are clear and leave no doubt upon the intention of the
contracting parties, the stipulations of the parties are controlling. 36
These principles bear upon the merits of the instant Petition, specifically on the Continuing
Surety Undertaking which Merrie Tan executed in favor of FMLFC, and the Receipt and
Release executed by FMLFC in favor of Yao.
In the main, the Court recalls the essentially solidary nature and the extent of a surety's
liability. Article 2047 of the Civil Code provides with clarity:
ARTICLE 2047. By guaranty a person, called the guarantor, binds himself to the creditor to
fulfill the obligation of the principal debtor in case the latter should fail to do so.
If a person binds himself solidarily with the principal debtor, the provisions of Section 4,
Chapter 3, Title I of this Book shall be observed. In such case the contract is called a
suretyship.
The above statutory definition of a suretyship provides that in a surety agreement, the
surety undertakes to be bound solidarily with the principal debtor, with their liabilities so
interwoven as to be inseparable. Accordingly, Articles 1207 up to 1222 of the Civil Code on
joint and solidary obligations govern suretyship.
In Philippine Charter Insurance Corporation v. Petroleum Distributors & Service
Corporation,37 the Court fleshed out the operation of a suretyship undertaking in this wise:
A contract of suretyship is an agreement whereby a party, called the surety, guarantees
the performance by another party, called the principal or obligor, of an obligation or
undertaking in favor of another party, called the obligee. Although the contract of a surety
is secondary only to a valid principal obligation, the surety becomes liable for the debt or
duty of another although it possesses no direct or personal interest over the obligations
nor does it receive any benefit therefrom. This was explained in the case of Stronghold
Insurance Company, Inc. v. Republic-Asahi Glass Corporation, where it was written:
The surety's obligation is not an original and direct one for the performance of his own act,
but merely accessory or collateral to the obligation contracted by the principal.
Nevertheless, although the contract of a surety is in essence secondary only to a
valid principal obligation, his liability to the creditor or promise of the principal is
said to be direct, primary and absolute; in other words, he is directly and equally
bound with the principal.
xxxx
Thus, suretyship arises upon the solidary binding of a person deemed the surety with the
principal debtor for the purpose of fulfilling an obligation. A surety is considered in law
as being the same party as the debtor in relation to whatever is adjudged
touching the obligation of the latter, and their liabilities are interwoven as to be
inseparable.38
It has also been noted by eminent civilist former CA Justice Eduardo P. Caguioa that
although the suretyship itself is a contract that is ancillary to the main financial
accommodation contract between the principal and the creditor, what sets the surety apart
from a mere guaranty is that in a suretyship, the surety is principally liable, as opposed to
a guarantor who is only secondarily liable.39 So much so that with a suretyship agreement
securing the loan transaction, a creditor may go directly against the surety even without a
prior demand on the principal debtor, although the latter may be solvent or otherwise able
to pay.40 A surety's liability stands irrespective of the principal debtor's ability to perform
his obligations under the contract which is subject of the suretyship. 41
In the instant controversy, Merrie Tan, along with Yao executed a "Continuing Surety
Undertaking; which has been described in Lim v. Security Bank Corp.42 as a continuing
suretyship:
Comprehensive or continuing surety agreements are, in fact, quite commonplace in
present day financial and commercial practice. A bank or financing company which
anticipates entering into a series of credit transactions with a particular company, normally
requires the projected principal debtor to execute a continuing surety agreement along
with its sureties. By executing such an agreement, the principal places itself in a position
to enter into the projected series of transactions with its creditor; with such suretyship
agreement, there would be no need to execute a separate surety contract or bond for each
financing or credit accommodation extended to the principal debtor.43
Continuing suretyships have been observed by the Court to be usual in the commercial
practice, where the principal places itself in a position to enter into projected series of
transactions with its creditor, with no more need to execute a separate surety contract for
each financial accommodation, since the continuing suretyship covers the subsequent ones
as well.44 These continuing suretyships have the effect of encouraging the creditor to
extend further accommodations without the fears and uncertainties that unsecured credits
carry.
Under the "Continuing Surety Undertaking" of the instant case, FMLFC may seek to
recover from NUMC, or from Merrie Tan or Ding, consistent with Article 1216 of the Civil
Code which provides:
Article 1216. The creditor may proceed against any one of the solidary debtors or
some or all of them simultaneously. The demand made against one of them shall not
be an obstacle to those which may subsequently be directed against the others, so long as
the debt has not been fully collected. (Emphasis supplied)
In fact, the Receipt and Release executed by FMLFC in favor of Yao categorically provides
for the reservation of its option to proceed against the remaining co-sureties Spouses Tan
and Ding, to wit:
Subject to the condition precedent that the above-mentioned check shall be duly honored
by the drawee bank upon presentment and in consideration of said payment, Malayan
Leasing agrees to (a) release Mr. Yao from his obligations as such surety, and (b) not to
file any case or action against Mr. Yao, whether civil, criminal or otherwise, arising under
or in connection with the remaining obligations of New Unitedware under the above-
mentioned Promissory Note and related documents.
This is without prejudice to the right of Malayan Leasing to exercise any and all
rights and remedies which it may have, either by contract or under applicable
law, against New Unitedware, and/or its officers, directors, stockholders and/or
sureties (excluding Mr. Yao).45
Clearly, as spelled out in the Receipt and Release, and consistent with its right as a
creditor of solidary obligors under Article 1216, FMLFC proceeded against Yao, later
released him from the suretyship upon payment of P980,000.00, and expressly reserved
its right to proceed against NUMC and/or its remaining co-sureties.
Therefore, Merrie Tan's submissions that (i) FMLFC is estopped from treating her and the
remaining co-sureties as solidary obligors since it accepted partial payment of NUMC's
outstanding loan obligation from Yao; and (ii) that said acceptance and subsequent release
amounted to a novation which converted the suretyship into a divisible obligation are both
misplaced.
On the contrary, FMLFC was well within its rights as a creditor to proceed against either
NUMC or any one or more or all of the co-sureties for the collection of NUMC's outstanding
loan. That it chose to first proceed against Yao and not against the other co-sureties did
not operate as an estoppel on it from subsequently proceeding against the remaining co-
sureties. More, that it agreed to release Yao upon the latter's payment of a partial amount
of the total loan obligation of NUMC also did not operate to bar it from proceeding against
the remaining co-sureties to ensure the full satisfaction of the debt. The liability of Merrie
Tan remains solidary with NUMC, regardless of partial payment by Yao, precisely because
the kind of security she undertook was one of suretyship. However, as the CA correctly
determined, the outstanding loan obligation for which Merrie Tan, NUMC and Ding remain
solidarily liable for has been effectively reduced by Yao's partial satisfaction of the same.
To be sure, the Court has so far acknowledged instances when a surety is discharged from
liability as a result of an act or omission of the creditor that may be declared negligent or
otherwise constitutive of a material alteration of the contract. 46 In Philippine National Bank
v. Manila Surety & Fidelity Co. Inc.,47 the surety was considered released since the creditor
therein was found negligent in allowing the assigned funds to be exhausted without
notifying the surety, thereby depriving the latter of any possibility of availing of a recourse
against that security. Similarly, in the case of Philippine National Bank v. Luzon Surety
Co., Inc.,48 the Court recognized that material alteration can be a ground for
release.49 In Palmares v. Court of Appeals,50 the Court mentioned that an extension of the
time of payment for a definite period without the consent or reservation of the rights of
the surety would release the latter.51
However, as far as the facts of the suretyship involving Spouses Tan and Ding are
concerned, none of the foregoing scenarios obtain. Therefore, contrary to Merrie Tan's
chief assertion, they are not released from the solidary obligation to pay FMLFC for NUMC's
remaining obligation.
In addition, and most unlike Merrie Tan's submission, these are not the height of injustice,
but only the very nature of a suretyship agreement. To be sure, in case Merrie Tan fully
pays for NUMC's outstanding obligation to FMLFC, she is not without recourse. For the
moment the surety fully answers to the creditor for the obligation created by the principal
debtor, such obligation is extinguished. At the same time, the surety may seek
reimbursement from the principal debtor for the amount paid, for the surety does in fact
become subrogated to all the rights and remedies of the creditor. 52 This remedy of Merrie
Tan as against her co-surety Yao is clearly provided for in Article 1217 of the Civil Code, to
wit:
Article 1217. Payment made by one of the solidary debtors extinguishes the obligation. If
two or more solidary debtors offer to pay, the creditor may choose which offer to accept.
He who made the payment may claim from his co-debtors only the share which
corresponds to each, with the interest for the payment already made. If the payment is
made before the debt is due, no interest for the intervening period may be demanded.
When one of the solidary debtors cannot, because of his insolvency, reimburse his share to
the debtor paying the obligation, such share shall be bore by all his co-debtors, in
proportion to the debt of each.
More, the intent of the law to ensure that the obligation of one surety to his co-sureties
survives even in the event of a partial or total condonation or remission of the debt owed
is likewise clearly provided for in Article 1219 of the Civil Code, which states, viz.:
The remission made by the creditor of the share which affects one of the solidary debtors
does not release the latter from his responsibility towards the co-debtors, in case the debt
had been totally paid by anyone of them before the remission was effected.
With respect to Merrie Tan's submission that the penalty charge, liquidated damages and
attorney's fees were improperly imposed, the Court is inclined to agree. The nature of a
penalty charge and liquidated damages are similar, and they may not be simultaneously
imposed in the instant case without violating the fundamental concepts of iniquity and
excessiveness, and notwithstanding the contractual autonomy of the parties herein.
To be sure, the characteristic autonomy of the contract as the law between agreeing
parties is acknowledged, as exemplified by the Promissory Note executed by NUMC in
favor of FMLFC, which provided for the penalty charge, liquidated damages and attorney's
fees in order to encourage performance of the obligation and deter nonpayment of the
same.
However, although the Court is not at liberty to ignore the expressed freedom of FMLFC
and NUMC to agree to such terms and conditions as they saw fit and convenient, the Court
is nevertheless well within its powers to determine the real intention of the parties in their
stipulations in the penalty clause, and to further make a finding as to whether said
impositions are iniquitous or unconscionably redundant.
In Filinvest Land Inc. v. Court of Appeals,53 the Court has held that by definition, a penal
clause in a contract is an accessory undertaking to assume greater liability in case of
breach, and is attached to an obligation in order to insure performance and serve a dual
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. 54 Article 1226
of the Civil Code states to this effect:
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. (Emphasis supplied)
To be sure, the Court recognized the nuanced approach that must be taken when both
liquidated damages and the penalty charge are imposed in the contract, as in the early
case of Laureano v. Kilayco,55 which instructed that a distinction between a penalty clause
imposed essentially as penalty in case of breach and a penalty clause imposed as
indemnity for damages should be made in cases where there has been neither partial nor
irregular compliance with the terms of the contract. 56
More specifically instructive is the case of D.M. Ragasa Enterprises, Inc. v. Banco De Oro,
Inc.57 (D.M. Ragasa), where the Court elaborated on the nature, source and purposes of a
penalty under a contract in order to deduce the true nature of a penalty clause, viz.:
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 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 non-compliance of the obligation; and (3) a strictly
penal purpose � this is to punish the debtor for non-fulfillment 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.
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. 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.
Evidently, the penal clause may be considered either reparation, compensation or
substitute for damages, on one hand, or as 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.
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). 58
Within the framework of the Court's operative definition of a penalty clause as explained
in D.M. Ragasa, but unlike the Court's appreciation in that case that the penal clause
therein was punitive in nature, in this case, the Court discerns as it so holds that the "late
payment charge" clause in the Promissory Note in the instant case is not punitive, but
compensatory, in that it serves the purpose of "funcion liquidatoria or to liquidate the
amount of damages to be awarded to the injured party in case of breach of the principal
obligation."59 To recall, the clause in the Promissory Note in the question provides:
Likewise, I/we hereby jointly and severally promise to pay a late payment charge on
any overdue sum under this note at the rate of five percent (5%) per month.
It is further agreed that if upon such default, attorney's services are availed of, an
additional sum equal to twenty five percent (25%) of the total sum due thereon, x x x,
shall be paid to the holder hereof for attorney's fees plus an additional sum equivalent
to twenty five percent (25%) of the total sum due x x x, for liquidated
damages aside from expenses of collection and the legal costs provided in the Rules of
Court.60
As may be gleaned from the above clause, and seen from the Court's discussion of a
penalty clause in D.M. Ragasa, although it clearly provides for the penalty charge at the
rate of 5% per month as distinct from the imposition of the 25% liquidated damages, it
nevertheless appears that the "late payment charge," as stipulated, was imposed not as
an addition to but in lieu of indemnity for damages and payment of interests in case of
default in payment, as squarely described in Article 1226 of the Civil Code. Consistent with
the operative definitions in D.M. Ragasa, the above-quoted "late payment charge" is
clearly reparatory and thereby particularly stipulates the amount of compensatory
damages to be paid by a defaulting party in case of breach.
Since this indemnifying function is already what liquidated damages are for, and since the
indemnification is already served by the imposition of the penalty of the "late payment
charge," the Court cannot now countenance the separate and simultaneous burdens of a
penalty charge and liquidated damages on the part of the principal debtor or the surety,
without agreeing to a carrying out of injustice by way of the unconscionable redundancy of
penalties.
Furthermore, with respect to the amount of damages, the Court also reminds that since
the penal clause is compensatory in purpose, the appropriate amount of damages is
resolved without need of proof since the stipulated indemnity represents a legitimate
estimate made by the parties of the damages caused by the breach. Once more on this
point, the Court, in D.M. Ragasa, teaches:
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.
Also, proof of actual damages suffered by the creditor is not necessary in order
that the penalty may be demanded.61
The Court however notes that if under Article 1229 of the Civil Code, 62 it may reduce rates
of interests and penalties which it discerns to be iniquitous, then with more reason can the
Court remove redundant charges that serve the same end with respect to ensuring
compliance of an undertaking under pains of costs.
The Court further reduces the stipulated attorney's fees for being unconscionable, for
whether there is an agreement, the courts can fix a reasonable compensation which
lawyers may receive for their professional services, as such falls within the regulatory
prerogative of the courts.63 On this score, Section 24, Rule 138 of the Rules of Court
enables such reduction despite stipulation in cases of unconscionability, viz.:
Sec. 24. Compensation of attorneys; agreement as to fees. � An attorney shall be
entitled to have and recover from his client no more than a reasonable compensation for
his services, with a view to the importance of the subject-matter of the controversy, the
extent of the services rendered, and professional standing of the attorney. No court shall
be bound by the opinion of attorneys as expert witnesses as to the proper compensation
but may disregard such testimony and base its conclusion on its professional knowledge. A
written contract for services shall control the amount to be paid therefor unless
found by the court to be unconscionable or unreasonable. (Emphasis supplied)
In determining the reasonableness of the attorney's fees that may be awarded in a given
case, illustrative are the guideposts that the Court provided in Rayos v. Hernandez:64
Stipulated attorney's fees are unconscionable whenever the amount is by far so
disproportionate compared to the value of the services rendered as to amount to fraud
perpetrated upon the client. This means to say that the amount of the fee contracted for,
standing alone and unexplained would be sufficient to show that an unfair advantage had
been taken of the client, or that a legal fraud had been perpetrated on him.
The decree of unconscionability or unreasonableness of a stipulated amount in a
contingent fee contract, will not, however, preclude recovery. It merely justifies the fixing
by the court of a reasonable compensation for the lawyer's services.
Generally, the amount of attorney's fees due is that stipulated in the retainer agreement
which is conclusive as to the amount of the lawyer's compensation. A stipulation on a
lawyer's compensation in a written contract for professional services ordinarily
controls the amount of fees that the contracting lawyer may be allowed, unless
the court finds such stipulated amount unreasonable or unconscionable. In the
absence thereof, the amount of attorney's fees is fixed on the basis of quantum merit, i.e.,
the reasonable worth of the attorney's services. Courts may ascertain also if the attorney's
fees are found to be excessive, what is reasonable under the circumstances. In no case,
however, must a lawyer be allowed to recover more than what is reasonable, pursuant to
Section 24, Rule 138 of the Rules of Court.
We have identified the circumstances to be considered in determining the reasonableness
of a claim for attorney's fees as follows: (1) the amount and character of the service
rendered; (2) labor, time, and trouble involved; (3) the nature and importance of the
litigation or business in which the services were rendered; (4) the responsibility imposed;
(5) the amount of money or the value of the property affected by the controversy or
involved in the employment; (6) the skill and experience called for in the performance of
the services; (7) the professional character and social standing of the attorney; (8) the
results secured; (9) whether the fee is absolute or contingent, it being recognized that an
attorney may properly charge a much larger fee when it is contingent than when it is not;
and (10) the financial capacity and economic status of the client have to be taken into
account in fixing the reasonableness of the fee. 65
Given the foregoing, the Court finds it fitting and so holds the further reduction of the
attorney's fees as awarded, from 10% of the total outstanding obligation, to the amount of
P100,000.00.
Finally, concerning the dismissal of the third-party complaint filed by Merrie Tan against
Yao on the ground of failure to pay the docket fees, the Court is inclined to qualify said
dismissal as one which must be without prejudice to a refiling of the same, with the
appropriate payment of legal fees. Apropos is the Court's counsel in the case of Heirs of
Reinoso, Sr. v. Court of Appeals66 (Heirs of Reinoso, Sr.) where the exceptions to the
general rule of dismissal upon non-payment of docket fees were outlined, thus:
The rule is that payment in full of the docket fees within the prescribed period is
mandatory. In Manchester v. Court of Appeals, it was held that a court acquires
jurisdiction over any case only upon the payment of the prescribed docket fee. The strict
application of this rule was, however, relaxed two (2) years after in the case
of Sun Insurance Office, Ltd. v. Asuncion, wherein the Court decreed that where
the initiatory pleading is not accompanied by the payment of the docket fee, the
court may allow payment of the fee within a reasonable period of time, but in no
case beyond the applicable prescriptive or reglementary period. This ruling was
made on the premise that the plaintiff had demonstrated his willingness to abide by
the rules by paying the additional docket fees required. Thus, in the more recent
case of United Overseas Bank v. Ros, the Court explained that where the party does not
deliberately intend to defraud the court in payment of docket fees, and manifests
its willingness to abide by the rules by paying additional docket fees when
required by the court, the liberal doctrine enunciated in Sun Insurance Office,
Ltd., and not the strict regulations set in Manchester, will apply. It has been on
record that the Court, in several instances, allowed the relaxation of the rule on non-
payment of docket fees in order to afford the parties the opportunity to fully ventilate their
cases on the merits. In the case of La Sulette College v. Pilotin, the Court stated:
Notwithstanding the mandatory nature of the requirement of payment of appellate docket
fees, we also recognize that its strict application is qualified by the following: first, failure
to pay those fees within the reglementary period allows only discretionary, not automatic,
dismissal; second, such power should be used by the court in conjunction with its exercise
of sound discretion in accordance with the tenets of justice and fair play, as well as with a
great deal of circumspection in consideration of all attendant circumstances.
While there is a crying need to unclog court dockets on the one hand, there is, on the
other, a greater demand for resolving genuine disputes fairly and equitably, for it is far
better to dispose of a case on the merit which is a primordial end, rather than on a
technicality that may result in injustice.67
In the instant case, the records show that at the level of the RTC, the third-party
complaint of Merrie Tan against Yao was admitted in its Order dated June 6, 2007, and
that Yao, for his part, filed his Compulsory Counterclaim thereto, without any mention of
the non-payment of docket fees.68 The records further show that Merrie Tan, et al. were
only notified of their non-payment of docket fees through the assailed CA Decision, after
which they immediately paid the filing fees to the Clerk of Court of the RTC, and thereafter
submitted proof of such payment along with the Motion for Reconsideration they filed
before the CA.69

It appears therefore that Merrie Tan's deportment upon notice of non-payment of the
docket fees is one which falls squarely within the Court's description in Heirs of Reinoso,
Sr. as one who has demonstrated willingness to abide by the rules and pay the necessary
legal fees, and has otherwise shown no ill will or intent to defraud the court.

For this reason, the Court finds that it was an available option for the RTC to have simply
accepted the docket fees that were belatedly paid and allowed the third-party complaint
against Yao due course. Nevertheless, since it is evidently too late in the day to order a
remand of the instant case solely for the purpose of giving due course to the third-party
complaint against Yao which was already twice dismissed, the Court here discerns that the
dismissal of said third-party complaint should have been made without prejudice to a
refiling, in order to keep open the recourse of Merrie Tan against Yao as her co-surety. In
this regard Merrie Tan can seek recourse with the appropriate RTC to seek a refund of the
filing fees she had paid for the third-party complaint.

WHEREFORE, premises considered, the Petition is hereby PARTLY GRANTED.

The Decision dated October 30, 2019 and Resolution dated November 24, 2020 of the
Court of Appeals in CA-G.R. CV No. 110069 are hereby AFFIRMED with MODIFICATION.
New Unitedware Marketing Corporation, Merrie Anne L. Tan and Sing Jian Zi a.k.a.
Samson Ding are ORDERED to jointly and severally PAY the First Malayan Leasing and
Finance Corporation the following:

The total judgment award shall be subject to interest at the rate of six percent (6%) per
annum from the finality of this Decision until its full satisfaction.

Finally, the third-party complaint filed by Merrie Anne Tan and Willy Tan against Edward
Yao is hereby DISMISSED without prejudice.

SO ORDERED.
 G.R. No. 190512, June 20, 2018 (Arts. 1226, 1227)
D.M. RAGASA ENTERPRISES, INC., Petitioner, v. BANCO DE ORO, INC. (FORMERLY
EQUITABLE PCI BANK, INC.), Respondent.
The Facts
On January 30, 1998, Ragasa and (Equitable Bank) executed a Contract of Lease 7 (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, 19988 up to
January 31, 20039, with a monthly rental of P122,607.00.10 The pertinent provisions of the
Lease Contract state, viz.:
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 (122,607) pesos based on P463.16 per
square meter per month inclusive of VAT 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 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.
xxxx
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 (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.
8. The TENANT voluntarily binds himself and agrees to the following without any coercion
or force by the LESSOR;
xxxx
m) The full deposit shall be forfeited in favor of the LESSOR upon non-compliance 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 non-compliance of any of the provisions of this Contract, especially non-
payment of two consecutive monthly rentals on time, shall mean the termination of this
Contract, and within five (5) days from the date of breach, non-compliance, 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;
xxxx
10. In the event that a Court Litigation has been resorted to by the LESSOR or LESSEE,
due to non-compliance 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 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 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-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 1226 23 of the Civil Code,
takes the place of damages and interests in case of breach. Hence, for breaching the
Lease Contract by pre-terminating 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 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 Php 3,146,596.42 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 Php 30,000.00; 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 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:
The CA ruled that the bank's failure to continue the Lease Contract until its expiration
constituted a breach of its provision. 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, denied
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 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 law33 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
xxxx
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.
8. The TENANT voluntarily binds himself and agrees to the following without any coercion
or force by the LESSOR;
xxxx
m) The full deposit shall be forfeited in favor of the LESSOR upon non-compliance of the
Term of the Contract of Lease by the TENANT, and cannot be applied to Rental;
xxxx
p) Breach or non-compliance of any of the provisions of this Contract, especially non-
payment of two consecutive monthly rentals on time, shall mean the termination of this
Contract, and within five (5) days from the date of breach, non-compliance, 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;
xxxx
10. In the event that a Court Litigation has been resorted to by the LESSOR or LESSEE,
due to non-compliance 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 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 non-compliance 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;
xxxx
m) The full deposit shall be forfeited in favor of the LESSOR upon non-compliance of the
Term of the Contract 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 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.
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 non-compliance of any of the provisions of this Contract, especially non-
payment 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 Corp. 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 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 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
In Riesenbeck v. Spouses Silvino Maceren, Jr. and Patricia Maceren 45 (Riesenbeck), the
Court observed:
The Contract of Lease was called off by respondents in virtue of Clauses No. 10 46 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 Peoples 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 �
[I]t is well to recall that contracts are respected as the law 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 (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 P 250,000.00,
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 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 establishments 55 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 non-compliance 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 the non-compliance 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 non-compliance 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 non-compliance of the obligation; and (3) a
strictly penal purpose � this is to punish the debtor for non-fulfillment of the main
obligation.59 While the first purpose is always present, 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
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.
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
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
As defined, liquidated damages are those agreed upon by the parties to a contract, to be
guilty party? If it is, then item 8(m) is both complementary and cumulative. If it is not,
paid in case of breach thereof.65 The amount of the liquidated damages is purely
then it is subsidiary and reparatory.
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. 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
Also, proof of actual damages suffered by the creditor is not necessary in order that the
noncompliance, if there is no stipulation to the contrary." Thus, the contract must
penalty may be demanded.67
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) seeks to insure or guarantee the completion of the lease period since its non-
compliance shall be met with a penalty. The degree of the coercive effect or impact of the
Item 8(m) does not expressly make a reservation for an additional claim for damages and
penalty to insure or guarantee the performance of the principal obligation depends largely
interests occasioned by the breach of the lease period. There is, however, another
on the stipulated amount of the liquidated damages. If the amount is substantial, then the
provision of the Lease Contract that is triggered by a default in item 8(m), to wit:
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 10. In the event that a Court Litigation has been resorted to by the LESSOR or
parties have agreed on a specific amount of penalty, P367,821.00 or the full deposit, the LESSEE, due to non-compliance 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 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 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 non-fulfillment 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
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 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.
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.
 G.R. No. 176425, June 05, 2013 (Arts. 1226-1227)
HEIRS OF MANUEL UY EK LIONG, REPRESENTED BY BELEN LIM VDA. DE
UY, Petitioners, v. MAURICIA MEER CASTILLO, HEIRS OF BUENAFLOR C. UMALI,
REPRESENTED BY NANCY UMALI, VICTORIA H. CASTILLO, BERTILLA C. RADA,
MARIETTA C. CAVANEZ, LEOVINA C. JALBUENA AND PHILIP M.
CASTILLO, Respondents.
The Facts
Alongside her husband, Felipe Castillo, respondent Mauricia Meer Castillo was the owner of
four parcels of land with an aggregate area of 53,307 square meters, situated in Silangan
Mayao, Lucena City and registered in their names under Transfer Certificate of Title (TCT)
Nos. T-42104, T-32227, T-31752 and T-42103. With the death of Felipe, a deed of
extrajudicial partition over his estate was executed by his heirs, namely,
Mauricia, Buenaflor Umali and respondents
Victoria Castillo, Bertilla Rada, Marietta Cavanez, Leovina Jalbuena
and Philip Castillo.� Utilized as security for the payment of a tractor purchased by
Mauricia’s nephew, Santiago Rivera, from Bormaheco, Inc., it appears, however, that the
subject properties were subsequently sold at a public auction where Insurance Corporation
of the Philippines (ICP) tendered the highest bid. Having consolidated its title, ICP likewise
sold said parcels in favor of Philippine Machinery Parts Manufacturing Co.,
Inc. (PMPMCI) which, in turn, caused the same to be titled in its name.4
On 29 September 1976, respondents and Buenaflor instituted Civil Case No. 8085 before
the then (CFI) of Quezon, for the purpose of seeking the annulment of the transactions
and/or proceedings involving the subject parcels, as well as the TCTs procured by
PMPMCI.5� Encountering financial difficulties in the prosecution of Civil Case No. 8085,
respondents and Buenaflor entered into an Agreement dated 20 September 1978 whereby
they procured the legal services of Atty. Edmundo Zepeda and the assistance
of Manuel Uy Ek Liong who, as financier, agreed to underwrite the litigation expenses
entailed by the case. In exchange, it was stipulated in the notarized Agreement that, in
the event of a favorable decision in Civil Case No. 8085, Atty. Zepeda and Manuel
would be entitled to “a share of (40%) percent of all the realties and/or monetary
benefits, gratuities or damages” which may be adjudicated in favor of respondents. 6
respondents and Buenaflor entered into another notarized agreement denominated as
a Kasunduan agreeing to/that:
1. sell their remaining (60%) percent share in the subject parcels in favor of Manuel
for the sum of P180,000.00.
2. that Manuel would pay a downpayment in the sum of P1,000.00 upon the
execution of the Kasunduan
3. respondents and Buenaflor would retain and remain the owners of a 1,750-square
meter portion of said real properties.
4. any party violating the Kasunduan would pay the aggrieved party a penalty fixed
in the sum of P50,000.00, together with the attorney’s fees and litigation
expenses incurred should a case be subsequently filed in court.
5. further enter into such other stipulations as would be necessary to ensure that the
sale would push through and/or in the event of illegality or impossibility of any part of
the Kasunduan.7
With his death,8 Manuel was survived by petitioners, Heirs of Manuel Uy Ek Liong, who
were later represented in the negotiations regarding the subject parcels and in this suit
by petitioner Belen Lim Vda. de Uy.� The record also shows that the proceedings in
Civil Case No. 8085 culminated in this Court’s rendition of a 13 September 1990 Decision
in G.R. No. 895619 in favor of respondents and Buenaflor.10� Subsequent to the finality
of the Court�s Decision,11 it appears that the subject parcels were subdivided in
accordance with the Agreement, with sixty (60%) percent thereof consisting of 31,983
square meters equally apportioned among and registered in the names of respondents and
Buenaflor under TCT Nos. T-72027, T-72028, T-72029, T-72030, T-72031, T-72032 and
T-72033.12 Consisting of 21,324 square meters, the remaining forty (40%) percent was, in
turn, registered in the names of petitioners and Atty. Zepeda under TCT No. T-72026.13
Supposedly acting on the advice of Atty. Zepeda, respondents wrote petitioners a letter
dated 22 March 1993, essentially informing petitioners that respondents were willing to
sell their sixty (60%) percent share in the subject parcels for the consideration of P500.00
per square meter.14� Insisting on the price agreed upon in the Kasunduan, however,
petitioners sent a letter dated 19 May 1993, requesting respondents to execute within 15
days from notice the necessary Deed of Absolute Sale over their 60% share as aforesaid,
excluding the 1,750-square meter portion specified in their agreement with Manuel.
Informed that petitioners were ready to pay the remaining P179,000.00 balance of the
agreed price,15 respondents wrote a 28 May 1993 reply, reminding the former of their
purported refusal of earlier offers to sell the shares of Leovina and of Buenaflor who had,
in the meantime, died.16 In a letter dated 1 June 1993, respondents also called
petitioners� attention to the fact, among others, that their right to ask for an additional
consideration for the sale was recognized under the Kasunduan.17
On 6 October 1993, petitioners commenced the instant suit with the filing of their
complaint for specific performance and damages against the respondents
and respondent Heirs of Buenaflor, as then represented by Menardo Umali. Faulting
respondents with unjustified refusal to comply with their obligation under the Kasunduan,
petitioners prayed that the former be ordered to execute the necessary Deed of Absolute
Sale over their shares in the subject parcels, with indemnities for moral and exemplary
damages, as well as attorney�s fees, litigation expenses and the costs of the
suit.18 Served with summons, respondents filed their Answer with Counterclaim and
Motion to File Third Party Complaint on 3 December 1993. Maintaining that the Agreement
and the Kasunduan were illegal for being unconscionable and contrary to public policy,
respondents averred that Atty. Zepeda was an indispensable party to the case. Together
with the dismissal of the complaint and the annulment of said contracts and TCT No. T-
72026, respondents sought the grant of their counterclaims for moral and exemplary
damages, as well as attorney�s fees and litigation expenses. 19
The issues thereby joined, the (RTC), Branch 54, Lucena City, proceeded to conduct the
mandatory preliminary conference in the case.20 After initially granting respondents’ SO ORDERED.34nadcralavvonlinelawlibrary
motion to file a third party complaint against Atty. Zepeda, 21 the RTC, upon petitioners’
motion for reconsideration,22 went on to issue the 18 July 1997 Order disallowing the filing
Dissatisfied with the RTC�s decision, both petitioners35 and respondents perfected their
of said pleading on the ground that the validity of the Agreement and the cause of action
appeals36 which were docketed before the CA as CA-G.R. CV No. 84687.� While
against Atty. Zepeda, whose whereabouts were then unknown, would be better threshed
petitioners prayed for the increase of the monetary awards adjudicated a quo, as well as
out in a separate action.23 The denial24 of their motion for reconsideration of the foregoing
the further grant of liquidated damages in their favor, 37 respondents sought the complete
order25 prompted respondents to file a notice of appeal26 which was, however, denied due
reversal of the appealed decision on the ground that the Agreement and
course by the RTC on the ground that the orders sought to be appealed were non-
the Kasunduan were null and void.38 On 23 January 2007, the CA rendered the herein
appealable.27 On 14 December 1997, Menardo died28 and was substituted by his daughter
assailed decision, setting aside the RTC�s decision, upon the following findings and
Nancy as representative of respondent Heirs of Buenaflor. 29
conclusions, to wit: (a) the Agreement and Kasunduan are byproducts of the partnership
between Atty. Zepeda and Manuel who, as a non-lawyer, was not authorized to practice
In the ensuing trial of the case on the merits, petitioners called to the witness stand
law; (b) the Agreement is void under Article 1491 (5) of the Civil Code of the
Samuel Lim Uy Ek Liong30 whose testimony was refuted by Philip31 and Leovina32 during
Philippines which prohibits lawyers from acquiring properties which are the objects of the
the presentation of the defense evidence. On 27 January 2005, the RTC rendered a
litigation in which they have taken part; (c) jointly designed to completely deprive
decision finding the Kasunduan valid and binding between respondents and petitioners
respondents of the subject parcels, the Agreement and the Kasunduan are invalid and
who had the right to demand its fulfillment as Manuel�s successors-in-interest.�
unconscionable; and (d) without prejudice to his liability for violation of the Canons of
Brushing aside Philip�s testimony that respondents were forced to sign the Kasunduan,
Professional Responsibility, Atty. Zepeda can file an action to collect attorney�s fees
the RTC ruled that said contract became effective upon the finality of this Court�s 13
based on quantum meruit.39
September 1990 Decision in G.R. No. 89561 which served as a suspensive condition
therefor. Having benefited from the legal services rendered by Atty. Zepeda and the
The Issue
financial assistance extended by Manuel, respondents were also declared estopped from
questioning the validity of the Agreement, Kasunduan and TCT No. T-72026. With
Petitioners seek the reversal of the CA’s decision on the following issue:
the Kasunduan upheld as the law between the contracting parties and their privies, 33 the
RTC disposed of the case in the following wise:cralavvonlinelawlibrary
WHETHER [OR NOT] THE HONORABLE COURT OF APPEALS, FIFTEENTH DIVISION,
COMITTED A REVERSIBLE ERROR WHEN IT REVERSED AND SET ASIDE THE DECISION OF
WHEREFORE, premises considered, the Court finds for the [petitioners] and hereby:
THE RTC BRANCH 59, LUCENA CITY, IN CIVIL CASE NO. 93-176 DECLARING THE
AGREEMENT AND KASUNDUAN VOID AB INITIO FOR BEING CONTRARY TO LAW AND
1. Orders the [respondents] to execute and deliver a Deed of Conveyance in favor of the
PUBLIC POLICY FOR BEING VIOLATIVE OF ART. 1491 OF THE NEW CIVIL CODE AND THE
[petitioners] covering the 60% of the properties formerly covered by Transfer Certificates
CANONS OF PROFESSIONAL RESPONSIBILITY.40
of Title Nos. T-3175, 42104, T-42103, T-32227 and T-42104 which are now covered by
Transfer Certificates of Title Nos. T-72027, T-72028, T-72029, T-72030, T-72031, T-
72032, T-72033 and T-72026, all of the Registry of Deeds of Lucena City, for and in The Court’s Ruling
consideration of the amount of P180,000.00 in accordance with the provisions of
the KASUNDUAN, and We find the petition impressed with partial merit.

2. Orders the [petitioners] to pay and deliver to the [respondents] upon the latter�s
execution of the Deed of Conveyance mentioned in the preceding paragraph, the amount
of P179,000.00 representing the balance of the purchase price as provided in
the KASUNDUAN, and
3. Orders the [respondents] to pay the [petitioners] the following amounts:
a). P50,000.00 as and for moral damages;chanroblesvirtualawlibrary
b). P50,000.00 as and for exemplary damages; and
c). P50,000.00 as and for attorney�s fees.
and to pay the costs.
At the outset, it bears pointing out that the complaint for specific performance filed before
the RTC sought only the enforcement of petitioners� rights and respondents�
obligation under the Kasunduan. Although the answer filed by respondents also assailed
the validity of the Agreement and TCT No. T-72026, the record shows that the RTC, in its
order dated 18 July 1997, disallowed the filing of a third-party complaint against Atty.
Zepeda on the ground that the causes of action in respect to said contract and title would
be better threshed out in a separate action. As Atty. Zepeda�s whereabouts were then
unknown, the RTC also ruled that, far from contributing to the expeditious settlement of
the case, the grant of respondents� motion to file a third-party complaint would only
delay the proceedings in the case.41 With the 1 October 1998 denial of their motion for
reconsideration of the foregoing order, respondents subsequently filed a notice of appeal
which was, however, denied due course on the ground that the orders denying their
motion to file a third-party complaint and their motion for reconsideration were
interlocutory and non-appealable.42
Absent a showing that the RTC�s ruling on the foregoing issues was reversed and set
aside, we find that the CA reversibly erred in ruling on the validity of the Agreement which
respondents executed not only with petitioners� predecessor-in-interest, Manuel, but
also with Atty. Zepeda.� Since it is generally accepted that no man shall be affected by
any proceeding to which he is a stranger,43 the rule is settled that a court must first
acquire jurisdiction over a party � either through valid service of summons or voluntary
appearance � for the latter to be bound by a court decision. 44 The fact that Atty. Zepeda
was not properly impleaded in the suit and given a chance to present his side of the
controversy before the RTC should have dissuaded the CA from invalidating the Agreement
and holding that attorney�s fees should, instead, be computed on a quantum
meruit basis. Admittedly, Article 1491 (5)45 of the Civil Code prohibits lawyers from
acquiring by purchase or assignment the property or rights involved which are the object
of the litigation in which they intervene by virtue of their profession. The CA lost sight of
the fact, however, that the prohibition applies only during the pendency of the suit 46 and
generally does not cover contracts for contingent fees where the transfer takes effect only
after the finality of a favorable judgment.47
Although executed on the same day, it cannot likewise be gainsaid that the Agreement
and the Kasunduan are independent contracts, with parties, objects and causes different
from that of the other. Defined as a meeting of the minds between two persons
whereby one binds himself, with respect to the other to give something or to
render some service,48 a contract requires the concurrence of the following
requisites: (a) consent of the contracting parties; (b) object certain which is the
subject matter of the contract; and, (c) cause of the obligation which is
established.49 Executed in exchange for the legal services of Atty. Zepeda and the
financial assistance to be extended by Manuel, the Agreement concerned respondents�
transfer of 40% of the avails of the suit, in the event of a favorable judgment in Civil Case
No. 8085. While concededly subject to the same suspensive condition,
the Kasunduan was, in contrast, concluded by respondents with Manuel alone, for the
purpose of selling in favor of the latter 60% of their share in the subject parcels for the
agreed price of P180,000.00. Given these clear distinctions, petitioners correctly argue
that the CA reversibly erred in not determining the validity of the Kasunduan independent
from that of the Agreement.
Viewed in the light of the autonomous nature of contracts enunciated under Article
130650 of the Civil Code, on the other hand, we find that the Kasunduan was correctly
found by the RTC to be a valid and binding contract between the parties.� Already
partially executed with respondents� receipt of P1,000.00 from Manuel upon the
execution thereof, the Kasunduan simply concerned the sale of the former�s 60% share
in the subject parcel, less the 1,750-square meter portion to be retained, for the agreed
consideration of P180,000.00. As a notarized document that carries the evidentiary weight
conferred upon it with respect to its due execution, 51 the Kasunduan was shown to have
been signed by respondents with full knowledge of its contents, as may be gleaned from
the testimonies elicited from Philip52 and Leovina.53
Although Philip had repeatedly claimed that respondents had been forced to sign the
Agreement and the Kasunduan, his testimony does not show such vitiation of consent as
would warrant the avoidance of the contract. He simply meant that respondents felt
constrained to accede to the stipulations insisted upon by Atty. Zepeda and Manuel who
were not otherwise willing to push through with said contracts. 54
At any rate, our perusal of the record shows that respondents� main objection to the
enforcement of the Kasunduan was the perceived inadequacy of the P180,000.00 which
the parties had fixed as consideration for 60% of the subject parcels. Rather than claiming
vitiation of their consent in the answer they filed a quo, respondents, in fact, distinctly
averred that the Kasunduan was tantamount to unjust enrichment and �a clear source
of speculative profit� at their expense since their remaining share in said properties had
�a current market value of P9,594,900.00, more or less.� 55 In their 22 March 1993
letter to petitioners, respondents also cited prices then prevailing for the sale of properties
in the area and offered to sell their 60% share for the price of P500.00 per square
meter56 or a total of P15,991,500.00. In response to petitioners� insistence on the price
originally agreed upon by the parties,57 respondents even invoked the last paragraph58 of
the Kasunduan to the effect that the parties agreed to enter into such other stipulations as
would be necessary to ensure the fruition of the sale. 59
In the absence of any showing, however, that the parties were able to agree on new
stipulations that would modify their agreement, we find that petitioners and respondents
are bound by the original terms embodied in the Kasunduan. Obligations arising from
contracts, after all, have the force of law between the contracting parties60 who
are expected to abide in good faith with their contractual commitments, not
weasel out of them.61 Moreover, 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 govern. In such cases, courts
have no authority to alter a contract by construction or to make a new contract
for the parties. Since their duty is confined to the interpretation of the one which
the parties have made for themselves without regard to its wisdom or folly, it has
been ruled that courts cannot supply material stipulations or read into the
contract words it does not contain.62 Indeed, courts will not relieve a party from
the adverse effects of an unwise or unfavorable contract freely entered into.63
Our perusal of the Kasunduan also shows that it contains a penal clause64 which provides
that a party who violates any of its provisions shall be liable to pay the aggrieved party a
penalty fixed at P50,000.00, together with the attorney�s fees and litigation expenses
incurred by the latter should judicial resolution of the matter becomes necessary. 65 An
accessory undertaking to assume greater liability on the part of the obligor in case of
breach of an obligation, the foregoing stipulation is a penal clause which serves to
strengthen the coercive force of the obligation and provides for liquidated damages for
such breach.66 �The obligor would then be bound to pay the stipulated indemnity
without the necessity of proof of the existence and the measure of damages caused by the
breach.�67 Articles 1226 and 1227 of the Civil Code state:
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.

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 fulfilment of the obligation and the satisfaction of the
penalty at the same time, unless this right has been clearly granted to him. However, if
after the creditor has decided to require the fulfilment of the obligation, the performance
thereof should become impossible without his fault, the penalty may be enforced.�

In the absence of a showing that they expressly reserved the right to pay the penalty in
lieu of the performance of their obligation under the Kasunduan, respondents were
correctly ordered by the RTC to execute and deliver a deed of conveyance over their 60%
share in the subject parcels in favor of petitioners. Considering that
the Kasunduan stipulated that respondents would retain a portion of their share consisting
of 1,700 square meters, said disposition should, however, be modified to give full effect to
the intention of the contracting parties. Since the parties also fixed liquidated damages in
the sum of P50,000.00 in case of breach, we find that said amount should suffice as
petitioners� indemnity, without further need of compensation for moral and exemplary
damages.� In obligations with a penal clause, the penalty generally substitutes the
indemnity for damages and the payment of interests in case of non-compliance. 68 Usually
incorporated to create an effective deterrent against breach of the obligation by making
the consequences of such breach as onerous as it may be possible, the rule is settled that
a penal clause is not limited to actual and compensatory damages 69

The RTC�s award of attorney�s fees in the sum of P50,000.00 is, however, proper.
Aside from the fact that the penal clause included a liability for said award in the event of
litigation over a breach of the Kasunduan, petitioners were able to prove that they
incurred said sum in engaging the services of their lawyer to pursue their rights and
protect their interests.70

WHEREFORE, premises considered, the Court of Appeals� assailed 23 January 2007

Decision is REVERSED and SET ASIDE. In lieu thereof, the RTC�s 27 January 2005
Decision is REINSTATED subject to the following MODIFICATIONS: (a) the exclusion of
a 1,750-square meter portion from the 60% share in the subject parcel respondents were
ordered to convey in favor of petitioners; and (b) the deletion of the awards of moral and
exemplary damages. The rights of the parties under the Agreement may be determined in
a separate litigation.

SO ORDERED.
 [G.R. NO. 172384 : September 12, 2007] (Art. 1226, 1229)
ERMINDA F. FLORENTINO, Petitioner, v. SUPERVALUE, INC., Respondent.
FACTS
Petitioner is doing business under the business name "Empanada Royale," a sole
proprietorship engaged in the retail of empanada with outlets in different malls and
business establishments within Metro Manila.4
Respondent, on the other hand, is a domestic corporation engaged in the business of
leasing stalls and commercial store spaces located inside SM Malls found all throughout the
country.5
On 8 March 1999, petitioner and respondent executed three Contracts of Lease containing
similar terms and conditions over the cart-type stalls at SM North Edsa and SM Southmall
and a store space at SM Megamall. The term of each contract is for a period of four
months and may be renewed upon agreement of the parties. 6
Upon the expiration of the original Contracts of Lease, the parties agreed to renew the
same by extending their terms until 31 March 2000.7
Before the expiration of said Contracts of Lease, or on 4 February 2000, petitioner
received two letters from the respondent, both dated 14 January 2000, transmitted
through facsimile transmissions.8
In the first letter, petitioner was charged with violating Section 8 of the Contracts of Lease
by not opening on 16 December 1999 and 26 December 1999.9
Respondent also charged petitioner with selling a new variety of empanada called "mini-
embutido" and of increasing the price of her merchandise from P20.00 to P22.00, without
the prior approval of the respondent.10
Respondent observed that petitioner was frequently closing earlier than the usual mall
hours, either because of non-delivery or delay in the delivery of stocks to her outlets,
again in violation of the terms of the contract. A stern warning was thus given to petitioner
to refrain from committing similar infractions in the future in order to avoid the
termination of the lease contract.11
In the second letter, respondent informed the petitioner that it will no longer renew the
Contracts of Lease for the three outlets, upon their expiration on 31 March 2000.12
In a letter-reply dated 11 February 2000, petitioner explained that the "mini-embutido" is
not a new variety of empanada but had similar fillings, taste and ingredients as those of
pork empanada; only, its size was reduced in order to make it more affordable to the
buyers.13
Such explanation notwithstanding, respondent still refused to renew its Contracts of Lease
with the petitioner. To the contrary, respondent took possession of the store space in SM
Megamall and confiscated the equipment and personal belongings of the petitioner found
therein after the expiration of the lease contract. 14
In a letter dated 8 May 2000, petitioner demanded that the respondent release the
equipment and personal belongings it seized from the SM Megamall store space and return
the security deposits, in the sum of P192,000.00, turned over by the petitioner upon
signing of the Contracts of Lease. On 15 June 2000, petitioner sent respondent another
letter reiterating her previous demands, but the latter failed or refused to comply
therewith.15
On 17 August 2000, an action for Specific Performance, Sum of Money and Damages was
filed by the petitioner against the respondent before the RTC of Makati, Branch 57.16
In her Complaint docketed as Civil Case No. 00-1015, petitioner alleged that the
respondent made verbal representations that the Contracts of Lease will be renewed from
time to time and, through the said representations, the petitioner was induced to
introduce improvements upon the store space at SM Megamall in the sum of P200,000.00,
only to find out a year later that the respondent will no longer renew her lease contracts
for all three outlets.17
In addition, petitioner alleged that the respondent, without justifiable cause and without
previous demand, refused to return the security deposits in the amount of P192,000.00.18
Further, petitioner claimed that the respondent seized her equipment and personal
belongings found inside the store space in SM Megamall after the lease contract for the
said outlet expired and despite repeated written demands from the petitioner, respondent
continuously refused to return the seized items.19
Petitioner thus prayed for the award of actual damages in the sum of P472,000.00,
representing the sum of security deposits, cost of improvements and the value of the
personal properties seized. Petitioner also asked for the award of P300,000.00 as moral
damages; P50,000.00 as exemplary damages; and P80,000.00 as attorney's fees and
expenses of litigation.20
For its part, respondent countered that petitioner committed several violations of the
terms of their Contracts of Lease by not opening from 16 December 1999 to 26 December
1999, and by introducing a new variety of empanada without the prior consent of the
respondent, as mandated by the provision of Section 2 of the Contract of Lease.
Respondent also alleged that petitioner infringed the lease contract by frequently closing
earlier than the agreed closing hours. Respondent finally averred that petitioner is liable
for the amount P106,474.09, representing the penalty for selling a new variety of
empanada, electricity and water bills, and rental adjustment, among other charges
incidental to the lease agreements. Respondent claimed that the seizure of petitioner's
personal belongings and equipment was in the exercise of its retaining lien, considering
that the petitioner failed to settle the said obligations up to the time the complaint was
filed.21
Considering that petitioner already committed several breaches of contract, the
respondent thus opted not to renew its Contracts of Lease with her anymore. The security
deposits were made in order to ensure faithful compliance with the terms of their lease
agreements; and since petitioner committed several infractions thereof, respondent was
justified in forfeiting the security deposits in the latter's favor.
On 30 April 2001, the RTC rendered a Judgment22 in favor of the petitioner and found that
the physical takeover by the respondent of the leased premises and the seizure of
petitioner's equipment and personal belongings without prior notice were illegal. The
decretal part of the RTC Judgment reads:
WHEREFORE, premises duly considered, judgment is hereby rendered ordering the [herein
respondent] to pay [herein petitioner] the amount of P192,000.00 representing the
security deposits made by the [petitioner] and P50,000.00 as and for attorney's fees.
The [respondent] is likewise ordered to return to the [petitioner] the various properties
seized by the former after settling her account with the [respondent].
Lastly, the [respondent] may choose either to reimburse the [petitioner] one half (1/2) of
the value of the improvements introduced by the plaintiff at SM Megamall should
[respondent] choose to appropriate the improvements to itself or require the [petitioner]
to remove the improvements, even though the principal thing may suffer damage thereby.
[Petitioner] shall not, however, cause anymore impairment upon the said leased premises
than is necessary.
The other damages claimed by the plaintiff are denied for lack of merit.
Aggrieved, the respondent appealed the adverse RTC Judgment to the Court of Appeals.
In a Decision23 dated 10 October 2003, the Court of Appeals modified the RTC Judgment
and found that the respondent was justified in forfeiting the security deposits and was not
liable to reimburse the petitioner for the value of the improvements introduced in the
leased premises and to pay for attorney's fees. In modifying the findings of the lower
court, the appellate court declared that in view of the breaches of contract committed by
the petitioner, the respondent is justified in forfeiting the security deposits. Moreover,
since the petitioner did not obtain the consent of the respondent before she introduced
improvements on the SM Megamall store space, the respondent has therefore no
obligation to reimburse the petitioner for the amount expended in connection with the said
improvements.24 The Court of Appeals, however, maintained the order of the trial court for
respondent to return to petitioner her properties after she has settled her obligations to
the respondent. The appellate court denied petitioner's Motion for Reconsideration in a
Resolution25 dated 19 April 2006.
Hence, this instant Petition for Review on Certiorari 26 filed by the petitioner assailing the
Court of Appeals Decision. For the resolution of this Court are the following issues:
I. Whether or not the respondent is liable to return the security deposits to the petitions.
II. Whether or not the respondent is liable to reimburse the petitioner for the sum of the
improvements she introduced in the leased premises.
III. Whether or not the respondent is liable for attorney's fees. 27
The appellate court, in finding that the respondent is authorized to forfeit the security
deposits, relied on the provisions of Sections 5 and 18 of the Contract of Lease, to wit:
Section 5. DEPOSIT. The LESSEE shall make a cash deposit in the sum of SIXTY
THOUSAND PESOS (P60,000.00) equivalent to three (3) months rent as security for the
full and faithful performance to each and every term, provision, covenant and condition of
this lease and not as a pre-payment of rent. If at any time during the term of this lease
the rent is increased[,] the LESSEE on demand shall make an additional deposit equal to
the increase in rent. The LESSOR shall not be required to keep the deposit separate from
its general funds and the deposit shall not be entitled to interest. The deposit shall remain
intact during the entire term and shall not be applied as payment for any monetary
obligations of the LESSEE under this contract. If the LESSEE shall faithfully perform every
provision of this lease[,] the deposit shall be refunded to the LESSEE upon the expiration
of this Lease and upon satisfaction of all monetary obligation to the LESSOR.
xxx
Section 18. TERMINATION. Any breach, non-performance or non-observance of the terms
and conditions herein provided shall constitute default which shall be sufficient ground to
terminate this lease, its extension or renewal. In which event, the LESSOR shall demand
that LESSEE immediately vacate the premises, and LESSOR shall forfeit in its favor the
deposit tendered without prejudice to any such other appropriate action as may be legally
authorized.28
Since it was already established by the trial court that the petitioner was guilty of
committing several breaches of contract, the Court of Appeals decreed that she cannot
therefore rightfully demand the return of the security deposits for the same are deemed
forfeited by reason of evident contractual violations.
It is undisputed that the above-quoted provision found in all Contracts of Lease is in the
nature of a penal clause to ensure petitioner's faithful compliance with the terms and
conditions of the said contracts.
A penal clause is an accessory undertaking to assume greater liability in case of breach. It
is attached to an obligation in order to insure performance and has a double function : (1)
to provide for liquidated damages, and (2) to strengthen the coercive force of the
obligation by the threat of greater responsibility in the event of breach.29 The obligor would
then be bound to pay the stipulated indemnity without the necessity of proof of the
existence and the measure of damages caused by the breach.30 Article 1226 of the Civil
Code states:
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.
As a general rule, courts are not at liberty to ignore the freedoms of the parties
to agree on such terms and conditions as they see fit as long as they are not
contrary to law, morals, good customs, public order or public policy.
Nevertheless, courts may equitably reduce a stipulated penalty in the contracts
in two instances: (1) if the principal obligation has been partly or irregularly
complied with; and (2) even if there has been no compliance if the penalty is
iniquitous or unconscionable in accordance with Article 1229 of the Civil Code
which clearly provides:
Art. 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.31
In ascertaining whether the penalty is unconscionable or not, this court set out the
following standard in Ligutan v. Court of Appeals,32 to wit:
The question of whether a penalty is reasonable or iniquitous can be partly subjective and
partly objective. Its resolution would depend on such factor 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. xxx. crvll
In the instant case, the forfeiture of the entire amount of the security deposits in the sum
of P192,000.00 was excessive and unconscionable considering that the gravity of the
breaches committed by the petitioner is not of such degree that the respondent was
unduly prejudiced thereby. It is but equitable therefore to reduce the penalty of the
petitioner to 50% of the total amount of security deposits.
It is in the exercise of its sound discretion that this court tempered the penalty for the
breaches committed by the petitioner to 50% of the amount of the security deposits. The
forfeiture of the entire sum of P192,000.00 is clearly a usurious and iniquitous penalty for
the transgressions committed by the petitioner. The respondent is therefore under the
obligation to return the 50% of P192,000.00 to the petitioner.
Turning now to the liability of the respondent to reimburse the petitioner for one-half of
the expenses incurred for the improvements on the leased store space at SM Megamall,
the following provision in the Contracts of Lease will enlighten us in resolving this issue:
Section 11. ALTERATIONS, ADDITIONS, IMPROVEMENTS, ETC. The LESSEE shall not make
any alterations, additions, or improvements without the prior written consent of LESSOR;
and all alterations, additions or improvements made on the leased premises, except
movable or fixtures put in at LESSEE's expense and which are removable, without defacing
the buildings or damaging its floorings, shall become LESSOR's property without
compensation/reimbursement but the LESSOR reserves the right to require the removal of
the said alterations, additions or improvements upon expiration of the lease.
The foregoing provision in the Contract of Lease mandates that before the petitioner can
introduce any improvement on the leased premises, she should first obtain respondent's
consent. In the case at bar, it was not shown that petitioner previously secured the
consent of the respondent before she made the improvements on the leased space in SM
Megamall. It was not even alleged by the petitioner that she obtained such consent or she
at least attempted to secure the same. On the other hand, the petitioner asserted that
respondent allegedly misrepresented to her that it would renew the terms of the contracts
from time to time after their expirations, and that the petitioner was so induced thereby
that she expended the sum of P200,000.00 for the improvement of the store space leased.
This argument was squarely addressed by this court in Fernandez v. Court of
Appeals,33 thus:
The Court ruled that the stipulation of the parties in their lease contract "to be renewable"
at the option of both parties stresses that the faculty to renew was given not to the lessee
alone nor to the lessor by himself but to the two simultaneously; hence, both must agree
to renew if a new contract is to come about.
Petitioner's contention that respondents had verbally agreed to extend the lease
indefinitely is inadmissible to qualify the terms of the written contract under the parole
evidence rule, and unenforceable under the statute of frauds. 34
Moreover, it is consonant with human experience that lessees, before occupying the leased
premises, especially store spaces located inside malls and big commercial establishments,
would renovate the place and introduce improvements thereon according to the needs and
nature of their business and in harmony with their trademark designs as part of their
marketing ploy to attract customers. Certainly, no inducement or misrepresentation from
the lessor is necessary for this purpose, for it is not only a matter of necessity that a
lessee should re-design its place of business but a business strategy as well.
In ruling that the respondent is liable to reimburse petitioner one half of the amount of
improvements made on the leased store space should it choose to appropriate the same,
the RTC relied on the provision of Article 1678 of the Civil Code which provides:
Art. 1678. If the lessee makes, in good faith, useful improvements which are suitable to
the use for which the lease is intended, without altering the form or substance of the
property leased, the lessor upon the termination of the lease shall pay the lessee one-half
of the value of the improvements at that time. Should the lessor refuse to reimburse said
amount, the lessee may remove the improvements, even though the principal thing may
suffer damage thereby. He shall not, however, cause any more impairment upon the
property leased than is necessary.
While it is true that under the above-quoted provision of the Civil Code, the lessor is under
the obligation to pay the lessee one-half of the value of the improvements made should
the lessor choose to appropriate the improvements, Article 1678 however should be read
together with Article 448 and Article 546 of the same statute, which provide:
Art. 448. The owner of the land on which anything has been built, sown or planted in good
faith, shall have the right to appropriate as his own the works, sowing or planting, after
payment of the indemnity provided for in articles 546 and 548, or to oblige the one who
built or planted to pay the price of the land, and the one who sowed, the proper rent.
However, the builder or planter cannot be obliged to buy the land if its value is
considerably more than that of the building or trees. In such case, he shall pay reasonable
rent, if the owner of the land does not choose to appropriate the building or trees after
proper indemnity. The parties shall agree upon the terms of the lease and in case of
disagreement, the court shall fix the terms thereof.
xxx
Art. 546. Necessary expenses shall be refunded to every possessor; but only possessor in
good faith may retain the thing until he has been reimbursed therefor.
Useful expenses shall be refunded only to the possessor in good faith with the same right
of retention, the person who has defeated him in the possession having the option of
refunding the amount of the expenses or of paying the increase in value which the thing
may have acquired by reason thereof.
Thus, to be entitled to reimbursement for improvements introduced on the property, the
petitioner must be considered a builder in good faith. Further, Articles 448 and 546 of the
Civil Code, which allow full reimbursement of useful improvements and retention of the
premises until reimbursement is made, apply only to a possessor in good faith, i.e., one
who builds on land with the belief that he is the owner thereof. A builder in good faith is
one who is unaware of any flaw in his title to the land at the time he builds on it. 35 In this
case, the petitioner cannot claim that she was not aware of any flaw in her title or was
under the belief that she is the owner of the subject premises for it is a settled fact that
she is merely a lessee thereof.ςηαñrοblεš νιr†υαl lαω lιbrαrÿ
In Geminiano v. Court of Appeals, 36 this Court was emphatic in declaring that lessees are
not possessors or builders in good faith, thus:
Being mere lessees, the private respondents knew that their occupation of the premises
would continue only for the life of the lease. Plainly, they cannot be considered as
possessors nor builders in good faith.
In a plethora of cases, this Court has held that Article 448 of the Civil Code, in relation to
Article 546 of the same Code, which allows full reimbursement of useful improvements and
retention of the premises until reimbursement is made, applies only to a possessor in good
faith, i.e., one who builds on land with the belief that he is the owner thereof. It does not
apply where one's only interest is that of a lessee under a rental contract; otherwise, it
would always be in the power of the tenant to "improve" his landlord out of his property.
Since petitioner's interest in the store space is merely that of the lessee under the lease
contract, she cannot therefore be considered a builder in good faith. Consequently,
respondent may appropriate the improvements introduced on the leased premises without
any obligation to reimburse the petitioner for the sum expended.
Anent the claim for attorney's fees, we resolve to likewise deny the award of the same.
Attorney's fees may be awarded when a party is compelled to litigate or to incur expenses
to protect its interest by reason of unjustified act of the other. 37
In the instant petition, it was not shown that the respondent unjustifiably refused to grant
the demands of the petitioner so as to compel the latter to initiate legal action to enforce
her right. As we have found herein, there is basis for respondent's refusal to return to
petitioner the security deposits and to reimburse the costs of the improvements in the
leased premises. The award of attorney's fees is therefore not proper in the instant case.
WHEREFORE, premises considered, the instant Petition is PARTLY GRANTED. The Court of
Appeals Decision dated 10 October 2003 in CA-G.R. CV No. 73853 is hereby AFFIRMED
with the MODIFICATION that the respondent may forfeit only 50% of the total amount of
the security deposits in the sum of P192,000.00, and must return the remaining 50% to
the petitioner. No costs.
SO ORDERED.
G.R. No.138980 September 20, 2005
FILINVEST LAND, INC., Petitioners,
vs.
HON. COURT OF APPEALS, PHILIPPINE AMERICAN GENERAL INSURANCE COMPANY, and
PACIFIC EQUIPMENT CORPORATION, Respondent.
The essential facts of the case, as recounted by the trial court, are as follows:
On 26 April 1978, Filinvest Land, Inc. ("FILINVEST", for brevity), a corporation engaged in the
development and sale of residential subdivisions, awarded to defendant Pacific Equipment Corporation
("PACIFIC", for brevity) the development of its residential subdivisions consisting of two (2) parcels of
land located at Payatas, Quezon City, the terms and conditions of which are contained in an
"Agreement". (Annex A, Complaint). To guarantee its faithful compliance and pursuant to the
agreement, defendant Pacific posted two (2) Surety Bonds in favor of plaintiff which were issued by
defendant Philippine American General Insurance ("PHILAMGEN", for brevity). (Annexes B and C,
Complaint).
Notwithstanding three extensions granted by plaintiff to defendant Pacific, the latter failed to finish the
contracted works. (Annexes G, I and K, Complaint). On 16 October 1979, plaintiff wrote defendant
Pacific advising the latter of its intention to takeover the project and to hold said defendant liable for all
damages which it had incurred and will incur to finish the project. (Annex "L", Complaint).
On 26 October 1979, plaintiff submitted its claim against defendant Philamgen under its performance
and guarantee bond (Annex M, Complaint) but Philamgen refused to acknowledge its liability for the
simple reason that its principal, defendant Pacific, refused to acknowledge liability therefore. Hence, this
action.
In defense, defendant Pacific claims that its failure to finish the contracted work was due to inclement
weather and the fact that several items of finished work and change order which plaintiff refused to
accept and pay for caused the disruption of work. Since the contractual relation between plaintiff and
defendant Pacific created a reciprocal obligation, the failure of the plaintiff to pay its progressing bills
estops it from demanding fulfillment of what is incumbent upon defendant Pacific. The acquiescence by
plaintiff in granting three extensions to defendant Pacific is likewise a waiver of the former’s right to
claim any damages for the delay. Further, the unilateral and voluntary action of plaintiff in preventing
defendant Pacific from completing the work has relieved the latter from the obligation of completing the
same.
On the other hand, Philamgen contends that the various amendments made on the principal contract
and the deviations in the implementation thereof which were resorted to by plaintiff and co-defendant
Pacific without its (defendant Philamgen’s) written consent thereto, have automatically released the
latter from any or all liability within the purview and contemplation of the coverage of the surety bonds it
has issued. Upon agreement of the parties to appoint a commissioner to assist the court in resolving the
issues confronting the parties, on 7 July 1981, an order was issued by then Presiding Judge Segundo
M. Zosa naming Architect Antonio Dimalanta as Court Commissioner from among the nominees
submitted by the parties to conduct an ocular inspection and to determine the amount of work
accomplished by the defendant Pacific and the amount of work done by plaintiff to complete the project.
On 28 November 1984, the Court received the findings made by the Court Commissioner. In arriving at
his findings, the Commissioner used the construction documents pertaining to the project as basis.
According to him, no better basis in the work done or undone could be made other than the contract
billings and payments made by both parties as there was no proper procedure followed in terminating
the contract, lack of inventory of work accomplished, absence of appropriate record of work progress
(logbook) and inadequate documentation and system of construction management.
Based on the billings of defendant Pacific and the payments made by plaintiff, the work accomplished
by the former amounted to ₱11,788,282.40 with the exception of the last billing (which was not acted
upon or processed by plaintiff) in the amount of ₱844,396.42. The total amount of work left to be
accomplished by plaintiff was based on the original contract amount less value of work accomplished by
defendant Pacific in the amount of ₱681,717.58 (12,470,000-11,788,282.42).
As regards the alleged repairs made by plaintiff on the construction deficiencies, the Court
Commissioner found no sufficient basis to justify the same. On the other hand, he found the additional
work done by defendant Pacific in the amount of ₱477,000.00 to be in order.
On 01 April 1985, plaintiff filed its objections to the Commissioner’s Resolution on the following grounds:
a) Failure of the commissioner to conduct a joint survey which according to the latter is indispensable to
arrive at an equitable and fair resolution of the issues between the parties;
b) The cost estimates of the commissioner were based on pure conjectures and contrary to the
evidence; and,
c) The commissioner made conclusions of law which were beyond his assignment or capabilities.
In its comment, defendant Pacific alleged that the failure to conduct joint survey was due to plaintiff’s
refusal to cooperate. In fact, it was defendant Pacific who initiated the idea of conducting a joint survey
and inventory dating back 27 November 1983. And even assuming that a joint survey were conducted,
it would have been an exercise in futility because all physical traces of the actual conditions then
obtaining at the time relevant to the case had already been obliterated by plaintiff.
On 15 August 1990, a Motion for Judgment Based on the Commissioner’s Resolution was filed by
defendant Pacific.
On 11 October 1990, plaintiff filed its opposition thereto which was but a rehash of objections to the
commissioner’s report earlier filed by said plaintiff.3
On the basis of the commissioner’s report, the trial court dismissed Filinvest’s complaint as well as
Pecorp’s counterclaim. It held:
In resolving this case, the court observes that the appointment of a Commissioner was a joint
undertaking among the parties. The findings of facts of the Commissioner should therefore not only be
conclusive but final among the parties. The court therefore agrees with the commissioner’s findings with
respect to
1. Cost to repair deficiency or defect – ₱532,324.02
2. Unpaid balance of work done by defendant - ₱1,939,191.67
3. Additional work/change order (due to defendant) – ₱475,000.00
The unpaid balance due defendant therefore is ₱1,939,191.67. To this amount should be added
additional work performed by defendant at plaintiff’s instance in the sum of ₱475,000.00. And from this
total of ₱2,414,191.67 should be deducted the sum of ₱532,324.01 which is the cost to repair the
deficiency or defect in the work done by defendant. The commissioner arrived at the figure of
₱532,324.01 by getting the average between plaintiff’s claim of ₱758,080.37 and defendant’s allegation
of ₱306,567.67. The amount due to defendant per the commissioner’s report is therefore
₱1,881,867.66.
Although the said amount of ₱1,881,867.66 would be owing to defendant Pacific, the fact remains that
said defendant was in delay since April 25, 1979. The third extension agreement of September 15, 1979
is very clear in this regard. The pertinent paragraphs read:
a) You will complete all the unfinished works not later than Oct. 15, 1979. It is agreed and understood
that this date shall DEFINITELY be the LAST and FINAL extension & there will be no further extension
for any cause whatsoever.
b) We are willing to waive all penalties for delay which have accrued since April 25, 1979 provided that
you are able to finish all the items of the contracted works as per revised CPM; otherwise you shall
continue to be liable to pay the penalty up to the time that all the contracted works shall have been
actually finished, in addition to other damages which we may suffer by reason of the delays incurred.
Defendant Pacific therefore became liable for delay when it did not finish the project on the date agreed
on October 15, 1979. The court however, finds the claim of ₱3,990,000.00 in the form of penalty by
reason of delay (₱15,000.00/day from April 25, 1979 to Jan. 15, 1980) to be excessive. A forfeiture of
the amount due defendant from plaintiff appears to be a reasonable penalty for the delay in finishing the
project considering the amount of work already performed and the fact that plaintiff consented to three
prior extensions.
The foregoing considered, this case is dismissed. The counterclaim is likewise dismissed.
No Costs.4
The Court of Appeals, finding no reversible error in the appealed decision, affirmed the same.
Hence, the instant petition grounded solely on the issue of whether or not the liquidated damages
agreed upon by the parties should be reduced considering that: (a) time is of the essence of the
contract; (b) the liquidated damages was fixed by the parties to serve not only as penalty in case
Pecorp fails to fulfill its obligation on time, but also as indemnity for actual and anticipated damages
which Filinvest may suffer by reason of such failure; and (c) the total liquidated damages sought is only
32% of the total contract price, and the same was freely and voluntarily agreed upon by the parties.
At the outset, it should be stressed that as only the issue of liquidated damages has been elevated to
this Court, petitioner Filinvest is deemed to have acquiesced to the other matters taken up by the courts
below. Section 1, Rule 45 of the 1997 Rules of Court states in no uncertain terms that this Court’s
jurisdiction in petitions for review on certiorari is limited to "questions of law which must be distinctly set
forth."5 By assigning only one legal issue, Filinvest has effectively cordoned off any discussion into the
factual issue raised before the Court of Appeals.6 In effect, Filinvest has yielded to the decision of the
Court of Appeals, affirming that of the trial court, in deferring to the factual findings of the commissioner
assigned to the parties’ case. Besides, as a general rule, factual matters cannot be raised in a petition
for review on certiorari. This Court at this stage is limited to reviewing errors of law that may have been
committed by the lower courts.7 We do not perceive here any of the exceptions to this rule; hence, we
are restrained from conducting further scrutiny of the findings of fact made by the trial court which have
been affirmed by the Court of Appeals. Verily, factual findings of the trial court, especially when affirmed
by the Court of Appeals, are binding and conclusive on the Supreme Court.8 Thus, it is settled that:
(a) Based on Pecorp’s billings and the payments made by Filinvest, the balance of work to be
accomplished by Pecorp amounts to ₱681,717.58 representing 5.47% of the contract work. This means
to say that Pecorp, at the time of the termination of its contract, accomplished 94.53% of the contract
work;
(b) The unpaid balance of work done by Pecorp amounts to ₱1,939,191.67;
(c) The additional work/change order due Pecorp amounts to ₱475,000.00;
(d) The cost to repair deficiency or defect, which is for the account of Pecorp, is ₱532,324.02; and
(e) The total amount due Pecorp is ₱1,881,867.66.
Coming now to the main matter, Filinvest argues that the penalty in its entirety should be respected as it
was a product of mutual agreement and it represents only 32% of the ₱12,470,000.00 contract price,
thus, not shocking and unconscionable under the circumstances. Moreover, the penalty was fixed to
provide for actual or anticipated liquidated damages and not simply to ensure compliance with the terms
of the contract; hence, pursuant to Laureano v. Kilayco,9 courts should be slow in exercising the
authority conferred by Art. 1229 of the Civil Code.
We are not swayed.
There is no question that the penalty of ₱15,000.00 per day of delay was mutually agreed upon by the
parties and that the same is sanctioned by law. A penal clause is an accessory undertaking to assume
greater liability in case of breach.10 It is attached to an obligation in order to insure performance11 and
has a double function: (1) to provide for liquidated damages, and (2) to strengthen the coercive force of
the obligation by the threat of greater responsibility in the event of breach.12 Article 1226 of the Civil
Code states:
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.
As a general rule, courts are not at liberty to ignore the freedom of the parties to agree on such
terms and conditions as they see fit as long as they are not contrary to law, morals, good
customs, public order or public policy.13 Nevertheless, courts may equitably reduce a stipulated
penalty in the contract in two instances: (1) if the principal obligation has been partly or
irregularly complied; and (2) even if there has been no compliance if the penalty is iniquitous or
unconscionable in accordance with Article 1229 of the Civil Code which provides:
Art. 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.
In herein case, the trial court ruled that the penalty charge for delay – pegged at ₱15,000.00 per day of
delay in the aggregate amount of ₱3,990,000.00 -- was excessive and accordingly reduced it to
₱1,881,867.66 "considering the amount of work already performed and the fact that [Filinvest]
consented to three (3) prior extensions." The Court of Appeals affirmed the ruling but added as well that
the penalty was unconscionable "as the construction was already not far from completion." Said the
Court of Appeals:
Turning now to plaintiff’s appeal, We likewise agree with the trial court that a penalty interest of
₱15,000.00 per day of delay as liquidated damages or ₱3,990,000.00 (representing 32% penalty of the
₱12,470,000.00 contract price) is unconscionable considering that the construction was already not far
from completion. Penalty interests are in the nature of liquidated damages and may be equitably
reduced by the courts if they are iniquitous or unconscionable (Garcia v. Court of Appeals, 167 SCRA
815, Lambert v. Fox, 26 Phil. 588). 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 (Art.
1229, New Civil Code). Moreover, plaintiff’s right to indemnity due to defendant’s delay has been
cancelled by its obligations to the latter consisting of unpaid works.
This Court finds no fault in the cost estimates of the court-appointed commissioner as to the cost to
repair deficiency or defect in the works which was based on the average between plaintiff’s claim of
₱758,080.37 and defendant’s ₱306,567.67 considering the following factors: that "plaintiff did not follow
the standard practice of joint survey upon take over to establish work already accomplished, balance of
work per contract still to be done, and estimate and inventory of repair" (Exhibit "H"). As for the cost to
finish the remaining works, plaintiff’s estimates were brushed aside by the commissioner on the
reasoned observation that "plaintiff’s cost estimate for work (to be) done by the plaintiff to complete the
project is based on a contract awarded to another contractor (JPT), the nature and magnitude of which
appears to be inconsistent with the basic contract between defendant PECORP and plaintiff
FILINVEST."14
We are hamstrung to reverse the Court of Appeals as it is rudimentary that the application of Article
1229 is essentially addressed to the sound discretion of the court.15 As it is settled that the project was
already 94.53% complete and that Filinvest did agree to extend the period for completion of the project,
which extensions Filinvest included in computing the amount of the penalty, the reduction thereof is
clearly warranted.
Filinvest, however, hammers on the case of Laureano v. Kilayco,16 decided in 1915, which cautions
courts to distinguish between two kinds of penalty clauses in order to better apply their authority in
reducing the amount recoverable. We held therein that:
. . . [I]n any case wherein there has been a partial or irregular compliance with the provisions in a
contract for special indemnification in the event of failure to comply with its terms, courts will rigidly
apply the doctrine of strict construction against the enforcement in its entirety of the
indemnification, where it is clear from the terms of the contract that the amount or character of the
indemnity is fixed without regard to the probable damages which might be anticipated as a result of a
breach of the terms of the contract; or, in other words, where the indemnity provided for is essentially a
mere penalty having for its principal object the enforcement of compliance with the contract. But the
courts will be slow in exercising the jurisdiction conferred upon them in article 1154 17 so as to
modify the terms of an agreed upon indemnification where it appears that in fixing such indemnification
the parties had in mind a fair and reasonable compensation for actual damages anticipated as a result
of a breach of the contract, or, in other words, where the principal purpose of the indemnification agreed
upon appears to have been to provide for the payment of actual anticipated and liquidated damages
rather than the penalization of a breach of the contract. (Emphases supplied)
Filinvest contends that the subject penalty clause falls under the second type, i.e., the principal purpose
for its inclusion was to provide for payment of actual anticipated and liquidated damages rather than the
penalization of a breach of the contract. Thus, Filinvest argues that had Pecorp completed the project
on time, it (Filinvest) could have sold the lots sooner and earned its projected income that would have
been used for its other projects.
Unfortunately for Filinvest, the above-quoted doctrine is inapplicable to herein case. The Supreme Court
in Laureano instructed that a distinction between a penalty clause imposed essentially as penalty in
case of breach and a penalty clause imposed as indemnity for damages should be made in cases
where there has been neither partial nor irregular compliance with the terms of the contract. In cases
where there has been partial or irregular compliance, as in this case, there will be no substantial
difference between a penalty and liquidated damages insofar as legal results are concerned.18 The
distinction is thus more apparent than real especially in the light of certain provisions of the Civil Code of
the Philippines which provides in Articles 2226 and Article 2227 thereof:
Art. 2226. Liquidated damages are those agreed upon by the parties to a contract to be paid in case of
breach thereof.
Art. 2227. Liquidated damages, whether intended as an indemnity or a penalty, shall be equitably
reduced if they are iniquitous or unconscionable.
Thus, we lamented in one case that "(t)here is no justification for the Civil Code to make an apparent
distinction between a penalty and liquidated damages because the settled rule is that there is no
difference between penalty and liquidated damages insofar as legal results are concerned and that
either may be recovered without the necessity of proving actual damages and both may be reduced
when proper."19
Finally, Filinvest advances the argument that while it may be true that courts may mitigate the amount of
liquidated damages agreed upon by the parties on the basis of the extent of the work done, this
contemplates a situation where the full amount of damages is payable in case of total breach of
contract. In the instant case, as the penalty clause was agreed upon to answer for delay in the
completion of the project considering that time is of the essence, "the parties thus clearly contemplated
the payment of accumulated liquidated damages despite, and precisely because of, partial
performance."20 In effect, it is Filinvest’s position that the first part of Article 1229 on partial performance
should not apply precisely because, in all likelihood, the penalty clause would kick in in situations where
Pecorp had already begun work but could not finish it on time, thus, it is being penalized for delay in its
completion.

The above argument, albeit sound,21 is insufficient to reverse the ruling of the Court of Appeals. It must
be remembered that the Court of Appeals not only held that the penalty should be reduced because
there was partial compliance but categorically stated as well that the penalty was unconscionable.
Otherwise stated, the Court of Appeals affirmed the reduction of the penalty not simply because there
was partial compliance per se on the part of Pecorp with what was incumbent upon it but, more
fundamentally, because it deemed the penalty unconscionable in the light of Pecorp’s 94.53%
completion rate.

In Ligutan v. Court of Appeals,22 we pointed out that the question of whether a penalty is reasonable or
iniquitous can be partly subjective and partly objective as 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."23

In herein case, there has been substantial compliance in good faith on the part of Pecorp which renders
unconscionable the application of the full force of the penalty especially if we consider that in 1979 the
amount of ₱15,000.00 as penalty for delay per day was quite steep indeed. Nothing in the records
suggests that Pecorp’s delay in the performance of 5.47% of the contract was due to it having acted
negligently or in bad faith. Finally, we factor in the fact that Filinvest is not free of blame either as it
likewise failed to do that which was incumbent upon it, i.e., it failed to pay Pecorp for work actually
performed by the latter in the total amount of ₱1,881,867.66. Thus, all things considered, we find no
reversible error in the Court of Appeals’ exercise of discretion in the instant case.

Before we write finis to this legal contest that had spanned across two and a half decades, we take note
of Pecorp’s own grievance. From its Comment and Memorandum, Pecorp, likewise, seeks affirmative
relief from this Court by praying that not only should the instant case be dismissed for lack of merit, but
that Filinvest should likewise be made to pay "what the Court Commissioner found was due defendant"
in the "total amount of ₱2,976,663.65 plus 12% interest from 1979 until full payment thereof plus
attorneys fees."24 Pecorp, however, cannot recover that which it seeks as we had already denied, in a
Resolution dated 21 June 2000, its own petition for review of the 27 May 1999 decision of the Court of
Appeals. Thus, as far as Pecorp is concerned, the ruling of the Court of Appeals has already attained
finality and can no longer be disturbed.

WHEREFORE, premises considered, the Decision of the Court of Appeals dated 27 May 1999 is
AFFIRMED. No pronouncement as to costs.

SO ORDERED.
G.R. No. 82082 March 25, 1988 (Arts. 1226, 1229)
INSULAR BANK OF ASIA AND AMERICA, plaintiff-appellant,
vs.
SPOUSES EPIFANIA SALAZAR and RICARDO SALAZAR, defendants-appellees.
The facts are not disputed.
On November 22, 1978, defendants-appellees Spouses Salazar obtained a loan from the plaintiff-
appellant in the amount of ( P42,050.00 ) payable on or before December 12, 1980. This loan
transaction was evidenced by a promissory note where the defendants-appellees bound themselves
jointly and severally to pay the amount with interest at 19% per annum and with the express authority to
increase without notice the rate of interest up to the maximum allowed by law and subject further to
penalty charges or liquidated damages upon default equivalent to 2% per month on any amount due
and unpaid. In the event the account was referred to an attorney for collection, the defendants-
appellees were also bound to pay 25% of any amount due as attorney's fees plus expenses of litigation
and costs.
In accordance with the agreement, the plaintiff-appellant increased the rate of interest to 21% pursuant
to Central Bank Circular No. 705 dated December 1, 1979.
The promissory note matured but the defendants-appellees failed to pay their account. It was only after
several demands that the defendants-appellees were able to make partial payment. As of November
25, 1983, they were able to pay a total of P68,676.75 which payments were applied to partially satisfy
the penalty and interest charges.
On September 12, 1984, the plaintiff-appellant filed a complaint with the Regional Trial Court alleging
that the defendants-appellees were indebted to IBAA in the amount of P87,647.19 as of September 15,
1984. including interest at 21% per annum penalty charges, and attorney's fees.
At the pre-trial on October 31, 1984, the parties and their counsels appeared. The defendant-spouses
admitted the execution of the promissory note in consideration of P48,050.00. The trial court then
rendered a summary judgment the dispositive portion of which reads:
WHEREFORE, judgment is hereby ordered in favor of the plaintiff ordering the defendant
spouses Ricardo Salazar and Epifania Salazar to pay Insular Bank of Asia and America (IBAA)
the sum of Eleven Thousand Two Hundred Fifty Three Pesos and Twenty Five Centavos
( P11,253.25 ), with interest thereon at the rate of 19% per annum from the filing of the complaint
on September 12, 1984 until fully paid. The defendants are further ordered to pay the plaintiff-
attorney's fees in the amount of one Thousand Pesos ( P1,000.00 ) and to pay the costs. (p. 4,
Plaintiff- Appellant's Brief).
Plaintiff-appellant now raises the following assigned errors:
I THE LOWER COURT ERRED IN NOT AWARDING TO PLAINTIFF-APPELLANT PENALTY
CHARGES OR LIQUIDATED DAMAGES IN THE AMOUNT OF 2% PER MONTH ON ALL AMOUNTS
DUE AND UNPAID;
II THE LOWER COURT ERRED IN NOT AWARDING INTEREST ON THE LOAN AT 21 % PER
ANNUM.
III THE LOWER COURT ERRED IN THE COMPUTATION OF THE AMOUNT OF OBLIGATION DUE
FROM DEFENDANTS-APPELLEES APPELLEES IN FAVOR OF PLAINTIFF-APPELLANT
III THE LOWER COURT ERRED IN NOT AWARDING PLAINTIFF- APPELLANT ATTORNEY'S FEES
EQUIVALENT TO 25% OF THE AMOUNT DUE AND EXPENSES OF LITIGATION; and
IV THE LOWER COURT ERRED IN NOT ORDERING DEFENDANTS-APELLEES TO JOINTLY AND
SEVERALLY PAY THE OBLIGATION. (pp. 4-5, Plaintiff-Appellant's Brief)
The Escalation Clause provided in the promissory note reads:
The interest herein charged shall be subject to in , without notice, depending on whatever policy
IBAA may in the future adopt conformable to law, especially to compensate for any in Central
Bank interests or rediscounting rates.
Finding strength in the argument that the promissory note is the contract between the parties and, under
the law, obligations arising from contracts have the force of law between the parties, the plaintiff-
appellant increased the interest rate to 21% per annum effective December 1, 1979 pursuant to Central
Bank Circular No. 705.
In line with the Court's ruling in the case of Banco Filipino v. Navarro (G.R. No. L-46591, July 28,1987),
the interest rate may not be increased by the plaintiff-appellant in the instant case. It is the nile that
escalation clauses are valid stipulations in commercial contracts to maintain fiscal stability and to retain
the value of money in long term contracts. However, the enforceability of such stipulations are subject to
certain conditions.
In the Banco Filipino case, the borrower questioned the additional interest charges on the loan of
P41,300.00 she obtained when the interest rates were increased from 12% to 17% per Central Bank
Circular No. 494, issued on January 2, 1976. In a letter written by the Central Bank to the borrower,
some clarifications were made. Pertinent portions of the letter read:
In this connection, please be advised that the Monetary Board, in its Resolution No. 1155 dated
June 11, 1976 adopted the following guidelines to govern interest rate adjustments by banks and
non-banks performing quasi- banking functions on loans already existing as of January 3, 1976,
in the light of Central Rank Circulars Nos. 492-498:
1 Only banks and non-bank financial intermediaries performing quasi-banking functions may
interest rates on I already existing as of January 2,1976, provided that:
a. The pertinent loan contracts/documents contain escalation clauses expressly
authorizing lending bank or non-bank performing quasi-banking functions to increase the
rate of interest stipulated in the contract, in the event that any law or Central Bank
regulation is promulgated increasing the maximum interest rate for loans; and
 b. Said loans were directly granted by them and the remaining maturities thereof were
more than 730 days as of January 2, 1976, and
2. The increase in the rate of interest can be effective only as of January 2, 1976 or on a later
date. (Emphasis supplied)
Moreover, in its comment and supplemental comment submit, ted upon orders of this Court, the Central
Bank took the position that the issuance of its circulars is a valid exercise of its authority to prescribe
maximum rates of interest and based on the general principles of contract, the Escalation Clause is a
valid provision in the loan agreement provided that- 41) the increased rate imposed or charged by
petitioner does not exceed the ceiling fixed by law or the Monetary Board; (2) the increase is made
effective not earlier than the effectivity of the law or regulation authorizing such an increase and (3) the
remaining maturities of the loans are more than 730 days as of the effectivity of the law or regulation
authorizing such an increase. (Emphasis supplied)
In the case at bar, the loan was obtained on November 21, 1978 and was payable on or before
November 12, 1980. Central Bank Circular No. 705, authorizing the increase from 19% to 21% was
issued on December 1, 1979. Obviously, as of this date, December 1, 1979, the remaining maturity of
the loan was less than 730 days. Hence, the plaintiff-appellant's second assignment of error is without
merit.
With respect to the penalty clause, we have upheld the validity of such agreements in several cases. As
the Court stated in the case of Government Service Insurance System v. Court of appeals (145 SCRA
311, 321):
In the Bachrach case (supra) the Supreme Court ruled that the Civil Code permits the agreement
upon a penalty apart from the interest. Should there be such an agreement, the penalty does not
include the interest, and as such the two are different and distinct things which may be
demanded separately. Reiterating the same principle in the later case of Equitable Banking
Corp. (supra), where this Court held that the stipulation about payment of such additional rate
partakes of the nature of a penalty clause, winch is sanctioned by law.
plaintiff-appellant did not even state in the complaint that the defendants-appellees had made partial
payments, making it appear that the spouses Salazars refused to pay the loan. In their answer with
counterclaim, the defendants-appellees alleged that the bank neglected to credit said payments in the
defendant's account folio and subjected it as it did to the additional charges. Furthermore, we agree with
the trial court that the bank has already profited considerably from the loan. In a span of about six (6)
years, the bank was enriched by P 26,626.75 (p. 17, Records). The penalty charges of 2% a month are,
therefore, out of proportion to the damage incurred by the bank. In accordance with Article 1229 of the
Civil Code, the Court is constrained to reduce the penalty for being highly iniquitous
With respect to the attorney's fees, the court is likewise empowered to reduce the same if they are
unreasonable or unconscionable notwithstanding the express contract for attorney's fees. The award of
one thousand ( P1,000.00 ) pesos by the trial court appears to be enough.
The promissory note signed by the defendants-appellants states that the loan of P42,050.00 shall bear
interest at the rate of 19% per annum. This would yield interest of P7,989.50 per annum or a total of P
46,339.10 from November 22, 1978 to September 12, 1984, the date of filing the complaint. Penalty
interest of 1% a month or 12% per annum is reasonable so that from December 12, 1980 up to
September 12, 1984, penalty charges should be P19,202.83. Considering that the defendants-
appellees have paid the amount of P68,676.75, they, therefore, owed the bank the amount of
P38,915.18 when the complaint was filed. There is no indication in the records as to the fluctuation of
actual interest rates from 1984 and, therefore, we order interest at the legal rate of 12% per annum on
the unpaid amount.
WHEREFORE, the decision of the lower court is MODIFIED. The defendants-appellants Ricardo
Salazar and Epifania Salazar are ordered to pay Insular Bank of Asia and America (IBAA) the sum of
THIRTY-EIGHT THOUSAND NINE HUNDRED PESOS and EIGHTEEN CENTAVOS (P38,915.18 )
with interest thereon at the rate of Twelve Percent (12%) per annum from the filing of the complaint until
fully paid.
SO ORDERED.

In the case of Equitable Banking Corporation v. Liwanag (32 SCRA 293, 297), the Court explained:

xxx xxx xxx

... We have not overlooked the 14% interest that appellant has been sentenced to pay. This may
appear to be usurious, but it is not so. The rate stipulated was 9%, subject, however, to an
additional rate of 5%, in the event of default. The stipulation about payment of such additional
rate partakes of the nature of a penalty clause, which is sanctioned by law, (Art. 1226, Civil Code
of the Philippines), although, the penalty may also be reduced by the courts if it is iniquitous or
unconscionable. (Art 1229, Civil Code of the Philippines). ...

Admittedly, the defendants-appellees in the instant case failed to pay the loan on the due date.
However, with earnest efforts, they tried to pay the loan little by little so that as of November 25, 1983, a
total of P68,676.75 had been paid. The plaintiff-appellant, on the other hand, merely applied this
amount to satisfy the penalty and interest charges which it additionally imposed. We do not find any
evidence of bad faith on the part of the defendants-appellees in their failure to pay the loan on time.
Efforts were indeed made to make good their promise. We note the trial court's observation that the
G.R. No. L-26339 December 14, 1979
MARIANO C. PAMINTUAN, petitioner-appellant,
vs.
COURT OF APPEALS and YU PING KUN CO., INC., respondent-appellees.
This case is about the recovery compensatory, damages for breach of a contract of sale in addition to
liquidated damages.
Mariano C. Pamintuan appealed from the judgment of the Court of Appeals wherein he was ordered to
deliver to Yu Ping Kun Co., Inc. certain plastic sheetings and, if he could not do so, to pay the latter
P100,559.28 as damages with six percent interest from the date of the filing of the complaint. The facts
and the findings of the Court of Appeals are as follows:
In 1960, Pamintuan was the holder of a barter license wherein he was authorized to export to Japan
1,000 metric tons of white flint corn valued at 47,000 United States dollars in exchange for a collateral
importation of plastic sheetings of an equivalent value.
By virtue of that license, he entered into an agreement to ship his corn to Tokyo Menka Kaisha, Ltd. of
Osaka, Japan in exchange for plastic sheetings. He contracted to sell the plastic sheetings to Yu Ping
Kun Co., Inc. for two hundred sixty-five thousand five hundred fifty pesos. The company undertook to
open an irrevocable domestic letter of credit for that amount in favor of Pamintuan.
It was further agreed that Pamintuan would deliver the plastic sheetings to the company at its bodegas
in Manila or suburbs directly from the piers "within one month upon arrival of" the carrying vessels. Any
violation of the contract of sale would entitle the aggreived party to collect from the offending party
liquidated damages in the sum of ten thousand pesos (Exh. A).
On July 28, 1960, the company received a copy of the letter from the Manila branch of Toyo Menka
Kaisha, Ltd. confirming the acceptance by Japanese suppliers of firm offers for the consignment to
Pamintuan of plastic sheetings valued at forty-seven thousand dollars. Acting on that information, the
company lost no time in securing in favor of Pamintuan an irrevocable letter of credit for two hundred
sixty-five thousand five hundred fifty pesos.
Pamintuan was apprised by the bank on August 1, 1960 of that letter of credit which made reference to
the delivery to Yu Ping Kun Co., Inc. on or before October 31, 1960 of 336, 360 yards of plastic
sheetings (p. 21, Record on Appeal).
On September 27 and 30 and October 4, 1960, the Japanese suppliers shipped to Pamintuan, through
Toyo Menka Kaisha, Ltd., the plastic sheetings in four shipments to wit: (1) Firm Offer No. 327 for
50,000 yards valued at $9,000; (2) Firm Offer No. 328 for 70,000 yards valued at $8,050; (3) Firm
Offers Nos. 329 and 343 for 175,000 and 18,440 yards valued at $22,445 and $2,305, respectively, and
(4) Firm Offer No. 330 for 26,000 yards valued at $5,200, or a total of 339,440 yards with an aggregate
value of $47,000 (pp. 4-5 and 239-40, Record on Appeal).
The plastic sheetings arrived in Manila and were received by Pamintuan. Out of the shipments,
Pamintuan delivered to the company's warehouse only the following quantities of plastic sheetings:
November 11, 1960 — 140 cases, size 48 inches by 50 yards. November 14, 1960 — 258 cases
out of 352 cases. November 15, 1960 — 11 cases out of 352 cases. November 15, 1960 — 10
cases out of 100 cases. November 15, 1960 — 30 cases out of 100 cases.
Pamintuan withheld delivery of (1) 50 cases of plastic sheetings containing 26,000 yards valued at
$5,200; (2) 37 cases containing 18,440 yards valued at $2,305; (3) 60 cases containing 30,000 yards
valued at $5,400 and (4) 83 cases containing 40,850 yards valued at $5,236.97. While the plastic
sheetings were arriving in Manila, Pamintuan informed the president of Yu Ping Kun Co., Inc. that he
was in dire need of cash with which to pay his obligations to the Philippine National Bank. Inasmuch as
the computation of the prices of each delivery would allegedly be a long process, Pamintuan requested
that he be paid immediately.
Consequently, Pamintuan and the president of the company, Benito Y.C. Espiritu, agreed to fix the price
of the plastic sheetings at P0.782 a yard, regardless of the kind, quality or actual invoice value thereof.
The parties arrived at that figure by dividing the total price of P265,550 by 339,440 yards, the aggregate
quantity of the shipments.
After Pamintuan had delivered 224,150 yards of sheetings of interior quality valued at P163,.047.87, he
refused to deliver the remainder of the shipments with a total value of P102,502.13 which were covered
by (i) Firm Offer No. 330, containing 26,000 yards valued at P29,380; (2) Firm Offer No. 343, containing
18,440 yards valued at P13,023.25; (3) Firm Offer No. 217, containing 30,000 yards valued at P30,510
and (4) Firm Offer No. 329 containing 40,850 yards valued at P29,588.88 (See pp. 243-2, Record on
Appeal).
As justification for his refusal, Pamintuan said that the company failed to comply with the conditions of
the contract and that it was novated with respect to the price.
On December 2, 1960, the company filed its amended complaint for damages against Pamintuan. After
trial, the lower court rendered the judgment mentioned above but including moral damages.
The unrealized profits awarded as damages in the trial court's decision were computed as follows (pp.
248-9, Record on Appeal):
(1) 26,000 yards with a contract price of Pl.13 per yard and a selling price at the time of delivery
of Pl.75 a yard........................................................... P16,120.00
(2) 18,000 yards with a contract price of P0.7062 per yard and selling price of Pl.20 per yard at
the time of delivery......................................... 9,105.67
(3) 30,000 yards with a contract price of Pl.017 per yard and a selling price of Pl.70 per yard.
20,490.00
(4) 40,850 yards with a contract price of P0.7247 per yard and a selling price of P1.25 a yard at
the time of delivery.............................................. 21,458.50 Total unrealized profits.......................
P67,174.17
The overpayment of P12,282.26 made to Pamintuan by Yu Ping Kun Co., Inc. for the 224,150 yards,
which the trial court regarded as an item of damages suffered by the company, was computed as
follows (p. 71, Record on Appeal):
Liquidation value of 224,150 yards at P0.7822 a
yard .............................................................................. P175,330.13
Actual peso value of 224,150 yards as per firm offers or as per
contract............................................ 163,047.87
Overpayment................................................................ P 12,282.26
To these two items of damages (P67,174.17 as unrealized profits and P12,282.26 as overpayment), the
trial court added (a) P10,000 as stipulated liquidated damages, (b) P10,000 as moral damages, (c)
Pl,102.85 as premium paid by the company on the bond of P102,502.13 for the issuance of the writ of
preliminary attachment and (d) P10,000 as attorney's fees, or total damages of P110,559.28) p. 250,
Record on Appeal). The Court of Appeals affirmed that judgment with the modification that the moral
damages were disallowed (Resolution of June 29, 1966).
Pamintuan appealed. The Court of Appeals in its decision of March 18, 1966 found that the contract of
sale between Pamintuan and the company was partly consummated. The company fulfilled its
obligation to obtain the Japanese suppliers' confirmation of their acceptance of firm offers totalling
$47,000. Pamintuan reaped certain benefits from the contract. Hence, he is estopped to repudiate it;
otherwise, he would unjustly enrich himself at the expense of the company.
The Court of Appeals found that the writ of attachment was properly issued. It also found that
Pamintuan was guilty of fraud because (1) he was able to make the company agree to change the
manner of paying the price by falsely alleging that there was a delay in obtaining confirmation of the
suppliers' acceptance of the offer to buy; (2) he caused the plastic sheetings to be deposited in the
bonded warehouse of his brother and then required his brother to make him Pamintuan), his attorney-
in-fact so that he could control the disposal of the goods; (3) Pamintuan, as attorney-in-fact of the
warehouseman, endorsed to the customs broker the warehouse receipts covering the plastic sheetings
withheld by him and (4) he overpriced the plastic sheetings which he delivered to the company.
The Court of Appeals described Pamintuan as a man "who, after having succeeded in getting another to
accommodate him by agreeing to liquidate his deliveries on the basis of P0.7822 per yard, irrespective
of invoice value, on the pretense that he would deliver what in the first place he ought to deliver anyway,
when he knew all the while that he had no such intention, and in the process delivered only the poorer
or cheaper kind or those which he had predetermined to deliver and did not conceal in his brother's
name and thus deceived the unwary party into overpaying him the sum of P 1 2,282.26 for the said
deliveries, and would thereafter refuse to make any further delivery in flagrant violation of his plighted
word, would now ask us to sanction his actuation" (pp. 61-62, Rollo).
The main contention of appellant Pamintuan is that the buyer, Yu Ping Kun Co., Inc., is entitled to
recover only liquidated damages. That contention is based on the stipulation "that any violation of the
provisions of this contract (of sale) shall entitle the aggrieved party to collect from the offending party
liquidated damages in the sum of P10,000 ".
Pamintuan relies on the rule that a penalty and liquidated damages are the same (Lambert vs. Fox 26
Phil. 588); 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 " (1st sentence of Art. 1226, Civil Code) and, it is argued, there is no such stipulation to the
contrary in this case and that "liquidated damages are those agreed upon by the parties to a contract, to
be paid in case of breach thereof" (Art. 2226, Civil Code).
We hold that appellant's contention cannot be sustained because the second sentence of article 1226
itself provides that I nevertheless, damages shall be paid if the obligor ... is guilty of fraud in the
fulfillment of the obligation". "Responsibility arising from fraud is demandable in all obligations" (Art.
1171, Civil Code). "In case of fraud, bad faith, malice or wanton attitude, the obligor shall be responsible
for an damages which may be reasonably attributed to the non-performance of the obligation" (Ibid, art.
2201).
The trial court and the Court of Appeals found that Pamintuan was guilty of fraud because he did not
make a complete delivery of the plastic sheetings and he overpriced the same. That factual finding is
conclusive upon this Court.
There is no justification for the Civil Code to make an apparent distinction between penalty and
liquidated damages because the settled rule is that there is no difference between penalty and
liquidated damages insofar as legal results are concerned and that either may be recovered without the
necessity of proving actual damages and both may be reduced when proper (Arts. 1229, 2216 and
2227, Civil Code. See observations of Justice J.B.L. Reyes, cited in 4 Tolentino's Civil Code, p. 251).
Castan Tobeñas notes that the penal clause in an obligation has three functions: "1. Una funcion
coercitiva o de garantia, consistente en estimular al deudor al complimiento de la obligacion principal,
ante la amenaza de tener que pagar la pena. 2. Una funcion liquidadora del daño, o sea la de evaluar
por anticipado los perjuicios que habria de ocasionar al acreedor el incumplimiento o cumplimiento
inadecuado de la obligacion. 3. Una funcion estrictamente penal, consistente en sancionar o castigar
dicho incumplimiento o cumplimiento inadecuado, atribuyendole consecuencias mas onerosas para el
deudor que las que normalmente lleva aparejadas la infraccion contractual. " (3 Derecho Civil Espanol,
9th Ed., p. 128).
The penalty clause is strictly penal or cumulative in character and does not partake of the nature of
liquidated damages (pena sustitutiva) when the parties agree "que el acreedor podra pedir, en el
supuesto incumplimiento o mero retardo de la obligacion principal, ademas de la pena, los danos y
perjuicios. Se habla en este caso de pena cumulativa, a differencia de aquellos otros ordinarios, en que
la pena es sustitutiva de la reparacion ordinaria." (Ibid, Castan Tobenas, p. 130).
After a conscientious consideration of the facts of the case, as found by Court of Appeals and the trial
court, and after reflecting on the/tenor of the stipulation for liquidated damages herein, the true nature of
which is not easy to categorize, we further hold that justice would be adequately done in this case by
allowing Yu Ping Kun Co., Inc. to recover only the actual damages proven and not to award to it the
stipulated liquidated damages of ten thousand pesos for any breach of the contract. The proven
damages supersede the stipulated liquidated damages.
This view finds support in the opinion of Manresa (whose comments were the bases of the new matter
found in article 1226, not found in article 1152 of the old Civil Code) that in case of fraud the difference
between the proven damages and the stipulated penalty may be recovered (Vol. 8, part. 1, Codigo Civil,
5th Ed., 1950, p. 483).

Hence, the damages recoverable by the firm would amount to ninety thousand five hundred fifty-nine
pesos and twenty-eight centavos (P90,559.28), with six percent interest a year from the filing of the
complaint.

With that modification the judgment of the Court of Appeals is affirmed in all respects. No costs in this
instance.

SO ORDERED.
G.R. No. 116285 October 19, 2001
ANTONIO TAN, petitioner,
vs.
COURT OF APPEALS and the CULTURAL CENTER OF THE PHILIPPINES, respondents.
On May 14, 1978 and July 6, 1978, petitioner Antonio Tan obtained two (2) loans each in the principal
amount of Two Million Pesos (P2,000,000.00), or in the total principal amount of Four Million Pesos
(P4,000,000.00) from respondent Cultural Center of the Philippines (CCP, for brevity) evidenced by two
(2) promissory notes with maturity dates on May 14, 1979 and July 6, 1979, respectively. Petitioner
defaulted but after a few partial payments he had the loans restructured by respondent CCP, and
petitioner accordingly executed a promissory note (Exhibit "A") on August 31, 1979 in the amount of
Three Million Four Hundred Eleven Thousand Four Hundred Twenty-One Pesos and Thirty-Two
Centavos (P3,411,421.32) payable in five (5) installments. Petitioner Tan failed to pay any installment
on the said restructured loan of Three Million Four Hundred Eleven Thousand Four Hundred Twenty-
One Pesos and Thirty-Two Centavos (P3,411,421.32), the last installment falling due on December 31,
1980. In a letter dated January 26, 1982, petitioner requested and proposed to respondent CCP a mode
of paying the restructured loan, i.e., (a) twenty percent (20%) of the principal amount of the loan upon
the respondent giving its conformity to his proposal; and (b) the balance on the principal obligation
payable in thirty-six (36) equal monthly installments until fully paid. On October 20, 1983, petitioner
again sent a letter to respondent CCP requesting for a moratorium on his loan obligation until the
following year allegedly due to a substantial deduction in the volume of his business and on account of
the peso devaluation. No favorable response was made to said letters. Instead, respondent CCP,
through counsel, wrote a letter dated May 30, 1984 to the petitioner demanding full payment, within ten
(10) days from receipt of said letter, of the petitioner’s restructured loan which as of April 30, 1984
amounted to Six Million Eighty-Eight Thousand Seven Hundred Thirty-Five Pesos and Three Centavos
(P6,088,735.03).
On August 29, 1984, respondent CCP filed in the RTC of Manila a complaint for collection of a sum of
money, docketed as Civil Case No. 84-26363, against the petitioner after the latter failed to settle his
said restructured loan obligation. The petitioner interposed the defense that he merely accommodated a
friend, Wilson Lucmen, who allegedly asked for his help to obtain a loan from respondent CCP.
Petitioner claimed that he has not been able to locate Wilson Lucmen. While the case was pending in
the trial court, the petitioner filed a Manifestation wherein he proposed to settle his indebtedness to
respondent CCP by proposing to make a down payment of One Hundred Forty Thousand Pesos
(P140,000.00) and to issue twelve (12) checks every beginning of the year to cover installment
payments for one year, and every year thereafter until the balance is fully paid. However, respondent
CCP did not agree to the petitioner’s proposals and so the trial of the case ensued.
On May 8, 1991, the trial court rendered a decision, the dispositive portion of which reads:
WHEREFORE, judgment is hereby rendered in favor of plaintiff and against defendant,
ordering defendant to pay plaintiff, the amount of P7,996,314.67, representing defendant’s
outstanding account as of August 28, 1986, with the corresponding stipulated interest and
charges thereof, until fully paid, plus attorney’s fees in an amount equivalent to 25% of said
outstanding account, plus P50,000.00, as exemplary damages, plus costs.
Defendant’s counterclaims are ordered dismissed, for lack of merit.
SO ORDERED.4
The trial court gave five (5) reasons in ruling in favor of respondent CCP. First, it gave little weight to the
petitioner’s contention that the loan was merely for the accommodation of Wilson Lucmen for the reason
that the defense propounded was not credible in itself. Second, assuming, arguendo, that the petitioner
did not personally benefit from the said loan, he should have filed a third party complaint against Wilson
Lucmen, the alleged accommodated party but he did not. Third, for three (3) times the petitioner offered
to settle his loan obligation with respondent CCP. Fourth, petitioner may not avoid his liability to pay his
obligation under the promissory note (Exh. "A") which he must comply with in good faith pursuant to
Article 1159 of the New Civil Code. Fifth, petitioner is estopped from denying his liability or loan
obligation to the private respondent.
The petitioner appealed the decision of the trial court to the Court of Appeals insofar as it charged
interest, surcharges, attorney’s fees and exemplary damages against the petitioner. In his appeal, the
petitioner asked for the reduction of the penalties and charges on his loan obligation. He abandoned his
alleged defense in the trial court that he merely accommodated his friend, Wilson Lucmen, in obtaining
the loan, and instead admitted the validity of the same. On August 31, 1993, the appellate court
rendered a decision, the dispositive portion of which reads:
WHEREFORE, with the foregoing modification, the judgment appealed from is hereby
AFFIRMED.
SO ORDERED.5
In affirming the decision of the trial court imposing surcharges and interest, the appellate court held that:
We are unable to accept appellant’s (petitioner’s) claim for modification on the basis of alleged
partial or irregular performance, there being none. Appellant’s offer or tender of payment
cannot be deemed as a partial or irregular performance of the contract, not a single centavo
appears to have been paid by the defendant.
However, the appellate court modified the decision of the trial court by deleting the award for exemplary
damages and reducing the amount of awarded attorney’s fees to five percent (5%), by ratiocinating as
follows:
Given the circumstances of the case, plus the fact that plaintiff was represented by a
government lawyer, We believe the award of 25% as attorney’s fees and P500,000.00 as
exemplary damages is out of proportion to the actual damage caused by the non-performance
of the contract and is excessive, unconscionable and iniquitous.
In a Resolution dated July 13, 1994, the appellate court denied the petitioner’s motion for
reconsideration of the said decision.
Hence, this petition anchored on the following assigned errors:
I
THE HONORABLE COURT OF APPEALS COMMITTED A MISTAKE IN GIVING ITS IMPRIMATUR TO
THE DECISION OF THE TRIAL COURT WHICH COMPOUNDED INTEREST ON SURCHARGES.
II
THE HONORABLE COURT OF APPEALS ERRED IN NOT SUSPENDING IMPOSITION OF
INTEREST FOR THE PERIOD OF TIME THAT PRIVATE RESPONDENT HAS FAILED TO ASSIST
PETITIONER IN APPLYING FOR RELIEF OF LIABILITY THROUGH THE COMMISSION ON AUDIT
AND THE OFFICE OF THE PRESIDENT.
III
THE HONORABLE COURT OF APPEALS ERRED IN NOT DELETING AWARD OF ATTORNEY’S
FEES AND IN REDUCING PENALTIES.
Significantly, the petitioner does not question his liability for his restructured loan under the promissory
note marked Exhibit "A". The first question to be resolved in the case at bar is whether there are
contractual and legal bases for the imposition of the penalty, interest on the penalty and attorney’s fees.
The petitioner imputes error on the part of the appellate court in not totally eliminating the award of
attorney’s fees and in not reducing the penalties considering that the petitioner, contrary to the appellate
court’s findings, has allegedly made partial payments on the loan. And if penalty is to be awarded, the
petitioner is asking for the non-imposition of interest on the surcharges inasmuch as the compounding
of interest on surcharges is not provided in the promissory note marked Exhibit "A". The petitioner takes
exception to the computation of the private respondent whereby the interest, surcharge and the
principal were added together and that on the total sum interest was imposed. Petitioner also claims
that there is no basis in law for the charging of interest on the surcharges for the reason that the New
Civil Code is devoid of any provision allowing the imposition of interest on surcharges.
We find no merit in the petitioner’s contention. 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 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.
In the case at bar, the promissory note (Exhibit "A") expressly provides for the imposition of both interest
and penalties in case of default on the part of the petitioner in the payment of the subject restructured
loan. The pertinent6 portion of the promissory note (Exhibit "A") imposing interest and penalties provides
that:
For value received, I/We jointly and severally promise to pay to the CULTURAL CENTER OF THE
PHILIPPINES at its office in Manila, the sum of THREE MILLION FOUR HUNDRED ELEVEN
THOUSAND FOUR HUNDRED + PESOS (P3,411,421.32) Philippine Currency, xxx.
xxx xxx xxx
With interest at the rate of FOURTEEN per cent (14%) per annum from the date hereof until
paid. PLUS THREE PERCENT (3%) SERVICE CHARGE.
In case of non-payment of this note at maturity/on demand or upon default of payment of any
portion of it when due, I/We jointly and severally agree to pay additional penalty charges at the
rate of TWO per cent (2%) per month on the total amount due until paid, payable and
computed monthly. Default of payment of this note or any portion thereof when due shall
render all other installments and all existing promissory notes made by us in favor of the
CULTURAL CENTER OF THE PHILIPPINES immediately due and demandable.
(Underscoring supplied)
xxx xxx xxx
The stipulated fourteen percent (14%) per annum interest charge until full payment of the loan
constitutes the monetary interest on the note and is allowed under Article 1956 of the New Civil
Code.7 On the other hand, the stipulated two percent (2%) per month penalty is in the form of penalty
charge which is separate and distinct from the monetary interest on the principal of the loan.
Penalty on delinquent loans may take different forms. In Government Service Insurance System v.
Court of Appeals,8 this Court has ruled that the New Civil Code permits an agreement upon a penalty
apart from the monetary interest. If the parties stipulate this kind of agreement, the penalty does not
include the monetary interest, and as such the two are different and distinct from each other and may
be demanded separately. Quoting Equitable Banking Corp. v. Liwanag,9 the GSIS case went on to state
that such a stipulation about payment of an additional interest rate partakes of the nature of a penalty
clause which is sanctioned by law, more particularly under Article 2209 of the New Civil Code which
provides that:
If the obligation consists in the payment of a sum of money, and the debtor incurs in delay, the
indemnity for damages, there being no stipulation to the contrary, shall be the payment of the
interest agreed upon, and in the absence of stipulation, the legal interest, which is six per cent
per annum.
The penalty charge of two percent (2%) per month in the case at bar began to accrue from the time of
default by the petitioner. There is no doubt that the petitioner is liable for both the stipulated monetary
interest and the stipulated penalty charge. The penalty charge is also called penalty or compensatory
interest. Having clarified the same, the next issue to be resolved is whether interest may accrue on the
penalty or compensatory interest without violating the provisions of Article 1959 of the New Civil Code,
which provides that:
Without prejudice to the provisions of Article 2212, interest due and unpaid shall not earn
interest. However, the contracting parties may by stipulation capitalize the interest due and
unpaid, which as added principal, shall earn new interest.
According to the petitioner, there is no legal basis for the imposition of interest on the penalty charge for
the reason that the law only allows imposition of interest on monetary interest but not the charging of
interest on penalty. He claims that since there is no law that allows imposition of interest on penalties,
the penalties should not earn interest. But as we have already explained, penalty clauses can be in the
form of penalty or compensatory interest. Thus, the compounding of the penalty or compensatory
interest is sanctioned by and allowed pursuant to the above-quoted provision of Article 1959 of the New
Civil Code considering that:
First, there is an express stipulation in the promissory note (Exhibit "A") permitting the compounding of
interest. The fifth paragraph of the said promissory note provides that: "Any interest which may be due if
not paid shall be added to the total amount when due and shall become part thereof, the whole amount
to bear interest at the maximum rate allowed by law."10 Therefore, any penalty interest not paid, when
due, shall earn the legal interest of twelve percent (12%) per annum,11 in the absence of express
stipulation on the specific rate of interest, as in the case at bar.
Second, Article 2212 of the New Civil Code provides that "Interest due shall earn legal interest from the
time it is judicially demanded, although the obligation may be silent upon this point." In the instant case,
interest likewise began to run on the penalty interest upon the filing of the complaint in court by
respondent CCP on August 29, 1984. Hence, the courts a quo did not err in ruling that the petitioner is
bound to pay the interest on the total amount of the principal, the monetary interest and the penalty
interest.
The petitioner seeks the elimination of the compounded interest imposed on the total amount based
allegedly on the case of National Power Corporation v. National Merchandising Corporation,12 wherein
we ruled that the imposition of interest on the damages from the filing of the complaint is unjust where
the litigation was prolonged for twenty-five (25) years through no fault of the defendant. However, the
ruling in the said National Power Corporation (NPC) case is not applicable to the case at bar inasmuch
as our ruling on the issue of interest in that NPC case was based on equitable considerations and on
the fact that the said case lasted for twenty-five (25) years "through no fault of the defendant." In the
case at bar, however, equity cannot be considered inasmuch as there is a contractual stipulation in the
promissory note whereby the petitioner expressly agreed to the compounding of interest in case of
failure on his part to pay the loan at maturity. Inasmuch as the said stipulation on the compounding of
interest has the force of law between the parties and does not appear to be inequitable or unjust, the
said written stipulation should be respected.
The private respondent’s Statement of Account (marked Exhibits "C" to "C-2")13 shows the following
breakdown of the petitioner’s indebtedness as of August 28, 1986:
Principal P2,838,454.68
Interest P 576,167.89
Surcharge P4,581,692.10
P7,996,314.67
The said statement of account also shows that the above amounts stated therein are net of the partial
payments amounting to a total of Four Hundred Fifty-Two Thousand Five Hundred Sixty-One Pesos
and Forty-Three Centavos (P452,561.43) which were made during the period from May 13, 1983 to
September 30, 1983.14 The petitioner now seeks the reduction of the penalty due to the said partial
payments. The principal amount of the promissory note (Exhibit "A") was Three Million Four Hundred
Eleven Thousand Four Hundred Twenty-One Pesos and Thirty-Two Centavos (P3,411,421.32) when
the loan was restructured on August 31, 1979. As of August 28, 1986, the principal amount of the said
restructured loan has been reduced to Two Million Eight Hundred Thirty-Eight Thousand Four Hundred
Fifty-Four Pesos and Sixty-Eight Centavos (P2,838,454.68). Thus, petitioner contends that reduction of
the penalty is justifiable pursuant to Article 1229 of the New Civil Code which provides that: "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." Petitioner insists that the penalty should be reduced to ten
percent (10%) of the unpaid debt in accordance with Bachrach Motor Company v. Espiritu.15
There appears to be a justification for a reduction of the penalty charge but not necessarily to ten
percent (10%) of the unpaid balance of the loan as suggested by petitioner. Inasmuch as petitioner has
made partial payments which showed his good faith, a reduction of the penalty charge from two percent
(2%) per month on the total amount due, compounded monthly, until paid can indeed be justified under
the said provision of Article 1229 of the New Civil Code.
In other words, we find the continued monthly accrual of the two percent (2%) penalty charge on the
total amount due to be unconscionable inasmuch as the same appeared to have been compounded
monthly.
Considering petitioner’s several partial payments and the fact he is liable under the note for the two
percent (2%) penalty charge per month on the total amount due, compounded monthly, for twenty-one
(21) years since his default in 1980, we find it fair and equitable to reduce the penalty charge to a
straight twelve percent (12%) per annum on the total amount due starting August 28, 1986, the date of
the last Statement of Account (Exhibits "C" to "C-2"). We also took into consideration the offers of the
petitioner to enter into a compromise for the settlement of his debt by presenting proposed payment
schemes to respondent CCP. The said offers at compromise also showed his good faith despite
difficulty in complying with his loan obligation due to his financial problems. However, we are not
unmindful of the respondent’s long overdue deprivation of the use of its money collectible from the
petitioner.
The petitioner also imputes error on the part of the appellate court for not declaring the suspension of
the running of the interest during that period when the respondent allegedly failed to assist the petitioner
in applying for relief from liability. In this connection, the petitioner referred to the private respondent’s
letter16 dated September 28, 1988 addressed to petitioner which partially reads:
Dear Mr. Tan:
xxx xxx xxx
With reference to your appeal for condonation of interest and surcharge, we wish to inform you
that the center will assist you in applying for relief of liability through the Commission on Audit
and Office of the President xxx.
While your application is being processed and awaiting approval, the center will be accepting
your proposed payment scheme with the downpayment of P160,000.00 and monthly
remittances of P60,000.00 xxx.
xxx xxx xxx
The petitioner alleges that his obligation to pay the interest and surcharge should have been suspended
because the obligation to pay such interest and surcharge has become conditional, that is dependent
on a future and uncertain event which consists of whether the petitioner’s request for condonation of
interest and surcharge would be recommended by the Commission on Audit and the Office of the
President to the House of Representatives for approval as required under Section 36 of Presidential
Decree No. 1445. Since the condition has not happened allegedly due to the private respondent’s
reneging on its promise, his liability to pay the interest and surcharge on the loan has not arisen. This is
the petitioner’s contention.

It is our view, however, that the running of the interest and surcharge was not suspended by the private
respondent’s promise to assist the petitioners in applying for relief therefrom through the Commission
on Audit and the Office of the President.

First, the letter dated September 28, 1988 alleged to have been sent by the respondent CCP to the
petitioner is not part of the formally offered documentary evidence of either party in the trial court. That
letter cannot be considered evidence pursuant to Rule 132, Section 34 of the Rules of Court which
provides that: "The court shall consider no evidence which has not been formally offered xxx." Besides,
the said letter does not contain any categorical agreement on the part of respondent CCP that the
payment of the interest and surcharge on the loan is deemed suspended while his appeal for
condonation of the interest and surcharge was being processed.

Second, the private respondent correctly asserted that it was the primary responsibility of petitioner to
inform the Commission on Audit and the Office of the President of his application for condonation of
interest and surcharge. It was incumbent upon the petitioner to bring his administrative appeal for
condonation of interest and penalty charges to the attention of the said government offices.

On the issue of attorney’s fees, the appellate court ruled correctly and justly in reducing the trial court’s
award of twenty-five percent (25%) attorney’s fees to five percent (5%) of the total amount due.

WHEREFORE, the assailed Decision of the Court of Appeals is hereby AFFIRMED with
MODIFICATION in that the penalty charge of two percent (2%) per month on the total amount due,
compounded monthly, is hereby reduced to a straight twelve percent (12%) per annum starting from
August 28, 1986. With costs against the petitioner.

SO ORDERED.