CKH Industrial and Development Corporation vs. Court of Appeals

For compensation—whether legal or conventional—to validly extinguish obligations, the parties must be mutually creditors and debtors of each other in their own right. The Court held that offsetting the purchase price owed by a corporate vendee against debts owed by the corporate vendor to individual stockholders of the vendee is invalid, because it violates the requisites of compensation and the principle of separate corporate personality.

Cheng Kim Heng, a Chinese immigrant, established CKH Industrial and Development Corporation (CKH) in the Philippines. Cheng had a first wife, Hung Yuk Wah, and children in Hong Kong—Chong Tak Kei (Kei) and Chong Tak Choi (Choi)—and a second wife in the Philippines, petitioner Rubi Saw. After Cheng's death in 1984, a dispute arose between Saw and the first family over CKH's properties, with Saw unilaterally assuming corporate control and attempting to evict Wah and her children from CKH premises. Respected mediators from the Chinese community, including respondent Uy Chi Kim, intervened. The mediation culminated in an agreement to sell CKH's two parcels of land in Valenzuela to Century-Well Phil. Corporation, a corporation owned partly by Kei, Choi, and Kei's wife, Lourdes Chong.

• The Disputed Sale: On May 8, 1988, Rubi Saw (for CKH) and Lourdes Chong (for Century-Well) met at the residence of mediator Uy Chi Kim and executed a Deed of Absolute Sale over two parcels of land for P800,000. The deed stated that the sum was "paid by VENDEE to VENDOR, receipt of which is hereby acknowledged." The deed was notarized the following day, May 9, 1988.
• Petitioners' Version: Petitioners alleged that prior to signing, Saw demanded payment via manager's check as agreed. Because it was a Sunday, Uy Chi Kim persuaded Saw to sign the deed and surrender the owner's copies of the titles, assuring her that the cash was downstairs in his store. Kim later returned with only P20,000, promising to produce the full amount the next day. When subsequent demands for payment went unheeded, petitioners sought to rescind the sale for lack of consideration.
• Respondents' Version: Private respondents contended that the sale was the product of a family settlement. They claimed the P800,000 purchase price was paid by P100,000 in cash (advanced by Uy Chi Kim and counted by Saw) and P700,000 by compensating or setting off three promissory notes executed by Cheng Kim Heng on behalf of CKH in favor of his sons, Choi and Kei.
• The Promissory Notes: The three promissory notes introduced as evidence unequivocally identified CKH as the debtor and Chong Tak Choi and Chong Tak Kei as the creditors. None of the notes indicated any indebtedness to Century-Well.

• Petitioners maintained that the consideration for the sale was never paid. They argued that the Deed of Absolute Sale, as written, provided for cash payment, not compensation.
• Petitioners contended that even if compensation were intended, it was legally impossible because CKH and Century-Well were not mutually creditors and debtors. The debts sought to be offset were owed by CKH to Choi and Kei in their personal capacities, not to Century-Well.
• Petitioners asserted that the corporate personalities of Century-Well and its stockholders are separate and distinct, precluding the offset of personal debts against corporate obligations.

• Respondents countered that the true agreement of the parties was to settle the family dispute by selling the property for P800,000, with P100,000 paid in cash and the P700,000 balance offset by Cheng's prior debts to his sons.
• Respondents argued that the acknowledgment of receipt in the Deed of Absolute Sale proved that payment had been made by compensation.
• Respondents invoked Article 1249 of the Civil Code, asserting that compensation is a valid mode of payment recognized by law.

• Procedural Issues: N/A
• Substantive Issues: Whether there was valid payment of the purchase price through legal or conventional compensation by offsetting CKH's debts to Chong Tak Choi and Chong Tak Kei against Century-Well's obligation to pay the purchase price.

• Procedural: N/A
• Substantive: The Court ruled that there was no valid compensation, warranting the rescission of the deed of sale for failure of consideration. Legal compensation under Article 1279 requires that each obligor be bound principally and be at the same time a principal creditor of the other. In this case, CKH and Century-Well—the principal contracting parties—were not mutually bound as creditors and debtors. The promissory notes proved that CKH owed Choi and Kei, not Century-Well. Conventional compensation likewise failed because Choi and Kei, who owned the credits, were not parties to the Deed of Absolute Sale and did not agree to the mutual extinguishment of their credits. Furthermore, because a corporation possesses a personality separate and distinct from its stockholders, the credits of Choi and Kei cannot be offset against the obligations of Century-Well. The Court declined to pierce the veil of corporate fiction absent any showing that the corporate entity was used to defeat public convenience, justify wrong, or protect fraud.

• Legal Compensation — Takes place by operation of law when two persons, in their own right, are creditors and debtors of each other. Requisites: (1) each obligor is principally bound and a principal creditor of the other; (2) both debts consist in a sum of money, or consumables of the same kind and quality; (3) both debts are due; (4) both debts are liquidated and demandable; (5) no retention or controversy commenced by third persons. Applied: Legal compensation cannot occur when the parties to the sale (CKH and Century-Well) are not the same parties to the debts being offset (CKH and Choi/Kei).
• Conventional Compensation — Occurs when parties mutually agree to compensate their respective obligations even if the requisites for legal compensation are absent. Requirements: (1) each party can dispose of the credit sought to be compensated, and (2) they agree to the mutual extinguishment of their credits. Applied: Conventional compensation failed because the parties to the sale did not own the credits being compensated; the credits belonged to Choi and Kei, who were not parties to the contract of sale.
• Separate Corporate Personality — A corporation has a personality distinct from its stockholders. The veil of corporate fiction is pierced only when the corporation is used to defeat public convenience, justify wrong, protect fraud, or defend crime, or where it is a mere alter ego. Applied: Choi and Kei's stockholdings in Century-Well did not make their civil personalities one with the corporation; thus, their personal credits could not be offset against the corporation's debt.

• "Without the confluence of the characters of mutual debtors and creditors, contracting parties cannot stipulate to the compensation of their obligations, for then the legal tie that binds contracting parties to their obligations would be absent. At least one party would be binding himself under an authority he does not possess."
• "In the instant case, there can be no valid compensation of the purchase price with the obligations of Cheng Kim Heng reflected in the promissory notes, for the reason that CKH and Century-Well the principal contracting parties, are not mutually bound as creditors and debtors in their own name."

• Soriano vs. Compania General de Tabacos de Filipinas, 125 Phil 80 — Cited as controlling authority on the parol evidence rule, which forbids the addition to or contradiction of the terms of a written instrument by testimony purporting to show different terms were agreed upon, subject to exceptions.
• Yu vs. National Labor Relations Commission, G.R. Nos. 111810-11, June 16, 1995, 245 SCRA 134 — Cited as controlling precedent for the doctrine that a corporation possesses a personality separate and distinct from its stockholders, and the circumstances under which the veil of corporate fiction may be pierced.

• Article 1231, Civil Code — Enumerates the modes of extinguishing obligations, including compensation. Applied to classify the nature of the alleged payment.
• Article 1249, Civil Code — Governs payment of debts in money and the effect of delivering promissory notes. Cited by respondents to argue compensation is a valid mode of payment.
• Article 1278, Civil Code — Provides that compensation takes place when two persons, in their own right, are creditors and debtors of each other. Applied to determine the necessity of mutual creditor-debtor relationship.
• Article 1279, Civil Code — Enumerates the five requisites of legal compensation. Applied to determine the invalidity of the offset due to the absence of mutual creditor-debtor relationship between the contracting parties.
• Article 1191, Civil Code — Provides the right to rescind obligations in case of breach. Applied as the basis for granting rescission due to failure of consideration.
• Section 9, Rule 130, Rules of Court — The parol evidence rule. Applied to establish the deed of sale as the best evidence of the agreement, though the Court ultimately looked to the validity of the mode of payment under substantive law.
• Section 2, Corporation Code — Defines corporate personality. Applied to affirm the separate juridical personality of Century-Well from its stockholders, Choi and Kei.

Regalado, Romero, Puno, and Mendoza, JJ.