Medel vs. Court of Appeals

Although the Usury Law has been rendered "legally inexistent" by Central Bank Circular No. 905, stipulated interest rates that are excessive, iniquitous, unconscionable, and exorbitant are void for being contrary to morals under Article 1306 of the Civil Code, and courts may equitably reduce such rates and corresponding penalty charges under Article 2227.

Spouses Veronica R. Gonzales and Danilo G. Gonzales, Jr. operated a money-lending business under the trade name "Gonzales Credit Enterprises" in Baliwag, Bulacan. Servando Franco and Leticia Medel (wife of Dr. Rafael Medel) were borrowers who obtained a series of short-term loans from Veronica Gonzales between November 1985 and July 1986, each evidenced by promissory notes bearing monthly interest rates of 5.5% to 6%. The legal backdrop includes Central Bank Circular No. 905, adopted on December 22, 1982, pursuant to Presidential Decree No. 116 as amended by P.D. No. 1684, which removed the interest ceilings prescribed by the Usury Law and rendered it "legally inexistent."

On November 7, 1985, Servando Franco and Leticia Medel obtained a loan of ₱50,000.00 from Veronica R. Gonzales, who operated a money-lending business under the name "Gonzales Credit Enterprises," payable in two months at 6% interest per month. Veronica released only ₱47,000.00, retaining ₱3,000.00 as advance interest for one month. Servando and Leticia executed a promissory note for ₱50,000.00 maturing on January 7, 1986. On November 19, 1985, they obtained a second loan of ₱90,000.00, again payable in two months at 6% per month, but received only ₱84,000.00. A promissory note maturing on January 19, 1986 was executed. Both notes went unpaid at maturity.

On June 11, 1986, Servando and Leticia secured a third loan of ₱300,000.00, maturing in one month and secured by a real estate mortgage over a property belonging to Leticia Makalintal Yaptinchay, who had issued a special power of attorney in favor of Leticia Medel authorizing the mortgage. Only ₱275,000.00 was actually released. This loan likewise went unpaid at maturity.

On July 23, 1986, Servando and Leticia, joined by the latter's husband Dr. Rafael Medel, consolidated all previous unpaid loans totaling ₱440,000.00 and obtained an additional ₱60,000.00, bringing their total indebtedness to ₱500,000.00. They executed a consolidated promissory note maturing on August 23, 1986, stipulating interest at 5.5% per month plus a 2% service charge per annum, a penalty of 1% per month on the amount due and demandable as liquidated damages, and attorney's fees equivalent to 25% of the total amount due. The borrowers again failed to pay at maturity.

On February 20, 1990, Veronica Gonzales, joined by her husband, filed a complaint for collection with the Regional Trial Court of Bulacan, Branch 16, at Malolos. Servando Franco answered alleging he signed the promissory note only as a witness and that it was Leticia and Dr. Rafael Medel who actually borrowed and benefited from the loan. Leticia and Rafael Medel, in their separate answer, contended that the loan was the transaction of Leticia Yaptinchay, that the interest rate was excessive, that the stipulation for 25% attorney's fees was unconscionable and illegal, and that substantial payments made were applied to interest, penalties, and other charges. After trial, the RTC found the due execution and genuineness of the promissory notes duly proved but ruled that the stipulated interest was unconscionable and "revolting to the conscience," applying instead the legal rate of 12% per annum.

• Excessive Interest Rate: Petitioners argued that the stipulated interest rate of 5.5% per month on the ₱500,000.00 loan was excessive, iniquitous, unconscionable, and exorbitant, and therefore void.
• Unconscionable Attorney's Fees: Petitioners maintained that the stipulation for attorney's fees equivalent to 25% of the total amount due was unconscionable, illegal, and excessive.
• Improper Application of Payments: Petitioners alleged that substantial payments they had made were applied to interest, penalties, and other charges rather than to the principal.

• Freedom to Stipulate Interest: Respondents argued that the consolidated promissory note was the law governing the parties and that, the Usury Law having become "legally inexistent" by virtue of CB Circular No. 905, the lender and borrower could agree on any interest rate.
• Applicability of Legal Rate Only in Absence of Stipulation: Respondents contended that Circular No. 416 of the Central Bank prescribing 12% per annum applied only in the absence of a stipulation on interest rate, not when the parties had agreed upon a rate.
• Validity of Penalty Charges: Respondents argued that the imposition of an additional 1% per month as penalty charges in the form of liquidated damages was allowed by law.

• Validity of Stipulated Interest Rate: Whether the stipulated interest rate of 5.5% per month (66% per annum) on the ₱500,000.00 loan is valid and enforceable notwithstanding the suspension of the Usury Law by Central Bank Circular No. 905.
• Judicial Power to Reduce Unconscionable Rates: Whether courts may equitably reduce stipulated interest rates and penalty charges found to be iniquitous or unconscionable even when the Usury Law is legally inexistent.

• Validity of Stipulated Interest Rate: No. The stipulated rate of 5.5% per month, or 66% per annum, is excessive, iniquitous, unconscionable, and exorbitant, and is void for being contrary to morals under Article 1306 of the Civil Code, notwithstanding the legal inexistence of the Usury Law.
• Judicial Power to Reduce Unconscionable Rates: Yes. Under Article 2227 of the Civil Code, courts shall reduce equitably liquidated damages, whether intended as an indemnity or a penalty, if they are iniquitous or unconscionable. The rate of 12% per annum plus 1% per month penalty was deemed reasonable.

• Validity of Stipulated Interest Rate: The Court acknowledged that Central Bank Circular No. 905, adopted on December 22, 1982, had removed the interest ceilings prescribed by the Usury Law, rendering the latter "legally inexistent." A Central Bank Circular cannot repeal a law — only a law can repeal another law — but Circular No. 905 suspended the Usury Law's effectivity, such that parties may now freely agree on interest rates. However, freedom to contract is not absolute. Under Article 1306 of the Civil Code, parties may establish stipulations, clauses, terms, and conditions as they may deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy. The stipulated rate of 5.5% per month, or 66% per annum, was found to be iniquitous and unconscionable, hence contrary to morals (contra bonos mores), if not against the law. The stipulation was therefore declared void. The Court agreed with the trial court that 12% per annum interest, plus an additional 1% per month as penalty charge, was more reasonable under the circumstances.

• Judicial Power to Reduce Unconscionable Rates: Article 2227 of the Civil Code provides that liquidated damages, whether intended as an indemnity or a penalty, shall be equitably reduced if they are iniquitous or unconscionable. This provision operates independently of the Usury Law and survives its suspension. The Court of Appeals erred in upholding the parties' stipulation in full; the proper course was to reduce the interest and penalty charges to reasonable levels, as the trial court had done.

• Unconscionable Interest Rates Are Void Notwithstanding CB Circular No. 905 — While Central Bank Circular No. 905 rendered the Usury Law "legally inexistent" by suspending its effectivity and allowing parties to freely stipulate on interest rates, such freedom is not absolute. Stipulated interest rates that are excessive, iniquitous, unconscionable, and exorbitant are void for being contrary to morals (contra bonos mores) under Article 1306 of the Civil Code. Courts retain the power to strike down and reduce such rates even in the absence of an effective Usury Law.
• Equitable Reduction of Liquidated Damages and Penalties — Under Article 2227 of the Civil Code, courts shall equitably reduce liquidated damages, whether intended as an indemnity or a penalty, if they are iniquitous or unconscionable. This judicial power is independent of the Usury Law and applies regardless of whether interest ceilings have been suspended.
• CB Circular Cannot Repeal a Law — A Central Bank Circular cannot repeal a law; only a law can repeal another law. Circular No. 905 did not repeal or amend the Usury Law but simply suspended its effectivity, rendering it "legally inexistent."

• "We agree with petitioners that the stipulated rate of interest at 5.5% per month on the P500,000.00 loan is excessive, iniquitous, unconscionable and exorbitant." — This is the Court's definitive characterization of the stipulated interest rate, forming the factual predicate for declaring the stipulation void.
• "Nevertheless, we find the interest at 5.5% per month, or 66% per annum, stipulated upon by the parties in the promissory note iniquitous or unconscionable, and, hence, contrary to morals ('contra bonos mores'), if not against the law. The stipulation is void." — This passage articulates the ratio decidendi: even with the Usury Law legally inexistent, unconscionable interest rates are void under Article 1306 of the Civil Code for being contrary to morals.
• "The courts shall reduce equitably liquidated damages, whether intended as an indemnity or a penalty if they are iniquitous or unconscionable." — This restates Article 2227 of the Civil Code as the independent statutory basis for judicial reduction of excessive rates and penalties, surviving the suspension of the Usury Law.

• Security Bank and Trust Company vs. Regional Trial Court of Makati, Branch 61 (331 Phil. 787 [1996]) — Followed for the proposition that CB Circular No. 905 did not repeal or amend the Usury Law but simply suspended its effectivity.
• Palanca vs. Court of Appeals (238 SCRA 593 [1994]) — Followed for the principle that a Central Bank Circular cannot repeal a law; only a law can repeal another law.
• Florendo vs. Court of Appeals (333 Phil. 535 [1996]) — Followed for the reiterated ruling that by virtue of CB Circular No. 905, the Usury Law has been rendered ineffective and usury is legally non-existent, allowing parties to agree on interest rates.
• People vs. Dizon (379 Phil. 687 [1996]) — Cited for the proposition that CB Circular No. 905 expressly removed the interest ceilings prescribed by the Usury Law.
• Liam Law vs. Olympic Sawmill Co. (129 SCRA 439 [1984]) — Cited for the holding that the Usury Law is now "legally inexistent."

• Article 1306, Civil Code — Allows parties to establish stipulations, clauses, terms, and conditions as they may deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy. Applied to void the stipulated interest rate of 5.5% per month as contrary to morals.
• Article 2227, Civil Code — Authorizes courts to equitably reduce liquidated damages, whether intended as an indemnity or a penalty, if they are iniquitous or unconscionable. Applied as the basis for reducing the stipulated interest and penalty charges to 12% per annum and 1% per month, respectively.
• Central Bank Circular No. 905 (adopted December 22, 1982, pursuant to P.D. No. 116 as amended by P.D. No. 1684) — Removed the interest ceilings prescribed by the Usury Law, rendering it "legally inexistent." The Court held that this Circular suspended but did not repeal the Usury Law, and that its effect did not preclude judicial invalidation of unconscionable interest rates.
• Central Bank Circular No. 416 — Prescribes the legal rate of interest at 12% per annum for loans or forbearance of money, goods, or credit. Applied by the trial court as the reasonable substitute rate after finding the stipulated rate unconscionable.

Narvasa, C.J., Romero, Kapunan, and Purisima, JJ., concurred.