New Sampaguita Builders Construction, Inc. (NSBCI) and Spouses Dee vs. Philippine National Bank

Courts have the authority to strike down or modify provisions in promissory notes that grant lenders unrestrained power to increase interest rates, penalties, and other charges at the latter’s sole discretion and without giving prior notice to and securing the consent of the borrowers, as such unilateral authority is anathema to the mutuality of contracts. Furthermore, excessive interests, penalties, and other charges not revealed in disclosure statements issued by banks, even if stipulated in the promissory notes, cannot be given effect under the Truth in Lending Act (Republic Act No. 3765).

The case arose from a commercial loan obtained by New Sampaguita Builders Construction, Inc. (NSBCI), a construction company, from the Philippine National Bank (PNB) in 1989 to finance various infrastructure projects including MWSS Watermain, NEA-Liberty farm, Olongapo City Pag-Asa Public Market, and others. The loan was secured by real estate mortgages over properties owned by the spouses Eduardo and Arcelita Dee, who also executed a Joint and Solidary Agreement making themselves sureties to the obligation. The dispute centered on PNB's unilateral escalation of interest rates and penalties after the borrower defaulted, leading to extrajudicial foreclosure and a claim for deficiency.

• On February 11, 1989, NSBCI's Board authorized the company to secure an P8 million commercial loan from PNB, using real estate properties of Spouses Eduardo and Arcelita Dee as collateral, with the spouses acting as sureties or co-obligors.
• On August 15, 1989, PNB approved the loan consisting of a P7.7 million revolving credit line and a P300,000 unadvised line for additional working capital to mobilize various construction projects.
• The loan was secured by a first mortgage on ten parcels of residential land in Pangasinan (totaling 7,418 square meters) and by the Joint and Solidary Agreement (JSA) executed by the spouses on August 31, 1989, making themselves "unconditionally and irrevocably" jointly and severally liable.
• NSBCI executed three promissory notes: (1) P5,000,000 dated June 29, 1989 due October 27, 1989 at 19.5% interest per annum; (2) P2,700,000 dated September 1, 1989 due December 30, 1989 at 21.5% interest; and (3) P300,000 dated September 6, 1989 due January 4, 1990 at 21.5% interest.
• Each promissory note contained a uniform escalation clause permitting PNB to increase the rate "within the limits allowed by law at any time depending on whatever policy it may adopt in the future" without prior notice to petitioners.
• Credit Agreements were executed on August 31, 1989 (for the revolving credit line) and September 5, 1989 (for the unadvised line), providing for interest at PNB's prime rate plus applicable spread, but did not contain provisions for unilateral interest increases.
• Disclosure Statements were issued showing effective interest rates of 19.5% and 21.5%, but did not disclose any provision for penalty increases or other charge increases.
• NSBCI made partial payments (totaling P2,724,956.22 from January 1990 to December 1991) but failed to pay the full amounts when the notes fell due. On June 18, 1991, Eduardo Dee requested a 90-day extension and loan restructuring.
• PNB unilaterally increased interest rates to between 26% to 35% and penalty rates from 6% to 36% per annum without petitioners' express consent, claiming authority under the escalation clauses.
• On January 30, 1992, PNB filed a petition for extrajudicial foreclosure under Act 3135. The auction sale was conducted on February 26, 1992, with PNB as highest bidder for P10,334,000.
• PNB claimed a deficiency of P2,172,476.43 after applying the auction proceeds to its total claim of P12,506,476.43, which included the escalated interest rates and penalties.

• The loan account was bloated by PNB through the imposition of excessive, iniquitous, and unconscionable interest rates, penalties, and other charges without legal, valid, or equitable justification.
• The unilateral increases in interest rates (from 19.5%/21.5% to 26-35%) and penalties (from 6% to 36%) violated the principle of mutuality of contracts under Article 1308 of the Civil Code.
• The escalation clauses in the promissory notes were void for being solely potestative, giving PNB unrestrained power to fix rates without borrower consent and making contract fulfillment dependent exclusively on PNB's will.
• The promissory notes and credit agreements were contracts of adhesion (contract d'adhésion), being standard pre-printed forms where petitioners had no bargaining power, and should be construed strictly against PNB under Article 1377 of the Civil Code.
• PNB failed to comply with the Truth in Lending Act (RA 3765) by not disclosing the increased penalty rates, service charges, and insurance premiums in the disclosure statements furnished to petitioners.
• The extrajudicial foreclosure proceedings were defective, premature, and attended by fraud, and the auction price was grossly inadequate compared to the actual fair market value of the properties.
• The spouses Dee argued they were merely guarantors (not solidary debtors), that the JSA was a contract of adhesion obtained through compulsion, and that allowing PNB to recover deficiency after taking the collateral would constitute unjust enrichment.
• Petitioners were entitled to PNB's Debt Relief Package (DRP) due to the economic slowdown affecting their projects near the US military bases in Angeles and Olongapo.
• The subsidiary ledgers of PNB were inaccurate, incomplete, and did not reflect the true state of the loan accounts, failing to show proper application of payments.

• The increases in interest rates were authorized by law (CB Circular 905) and the Monetary Board, and were voluntarily agreed upon by the parties in the Credit Agreements they executed.
• The escalation clauses were valid and necessary to maintain fiscal stability and retain the value of money on long-term contracts.
• The subsidiary ledgers were presumed accurate, regular, and fair under Section 5(q) of Rule 131 of the Rules of Court, and petitioners failed to rebut this presumption with sufficient evidence.
• The Debt Relief Package was not an automatic grant but a mere offer subject to specific terms, conditions, and approval by higher bank authorities (Branches Department Credit Committee and Board of Directors), which petitioners failed to qualify for due to lack of equity margin and repayment capability.
• The extrajudicial foreclosure was valid: notices were published in a newspaper of general circulation and posted in three public places, the sale was conducted by the provincial sheriff, and the bid price was neither shocking nor unconscionable.
• As sureties under the JSA, the spouses Dee were jointly and severally liable for the deficiency claim.
• The attorney's fees of 10% were justified and should be awarded as stipulated in the contract.

• Procedural Issues:
  • Whether the Supreme Court could review factual findings of the Court of Appeals in a Rule 45 petition for review on certiorari, despite the general rule that only questions of law may be raised.
• Substantive Issues:
  • Whether the loan accounts were bloated due to unconscionable and unilaterally imposed interest rates, penalties, and other charges.
  • Whether escalation clauses allowing PNB to unilaterally increase interest rates without borrower consent were valid under the principle of mutuality of contracts.
  • Whether penalty increases and other charges not disclosed in the Disclosure Statements could be collected under the Truth in Lending Act (RA 3765).
  • Whether the extrajudicial foreclosure proceedings and auction sale were valid and whether the bid price was adequate.
  • Whether PNB could recover the alleged deficiency claim from petitioners, including the spouses Dee as sureties.

• Procedural: The Supreme Court held that while Rule 45 petitions generally involve questions of law only, exceptions exist when: (1) the factual findings of the CA are manifestly mistaken; (2) the judgment is based on a misapprehension of facts; or (3) the CA manifestly overlooked certain relevant and undisputed facts that, if properly considered, would justify a different legal conclusion. The Court exercised its discretion to review factual issues in this case in the interest of justice.
• Substantive:
  • Unilateral Interest Rate Increases: The Court held that the "unilateral determination and imposition" of increased interest rates was violative of the principle of mutuality of contracts under Article 1308 of the Civil Code. While escalation clauses are valid to maintain fiscal stability, they cannot grant unrestrained power to one party to adjust rates unilaterally. The clauses made contract fulfillment dependent exclusively on PNB's uncontrolled will, rendering them void. Although CB Circular 905 lifted the Usury Law ceiling, it did not authorize unilateral rate increases without consent.
  • Rates Applied: The Court applied the stipulated rates of 19.5% (for the first promissory note) and 21.5% (for the second and third notes) until automatic conversion to medium-term loans after 730 days from original release, after which the legal rate of 12% per annum under CB Circular 416 applied.
  • Penalty Charges: The increase in penalty from 6% to 36% was held unjustified and unconscionable. Since penalty increases were not disclosed in the Disclosure Statements as required by the Truth in Lending Act (RA 3765), they could not be collected. The penalty was equitably reduced to zero (zilch) under Article 2227 of the Civil Code.
  • Other Charges: Service charges and insurance charges not specified in the Disclosure Statements or loan documents were disallowed.
  • Attorney's Fees: Reduced to 1% of the total amount due (from the stipulated 10%) as they were not an integral part of the cost of borrowing but arose only when collection became necessary, and the foreclosure was administrative in nature not involving difficult litigation.
  • Debt Relief Package: Petitioners failed to establish entitlement to the DRP as they did not prove they were seriously and directly affected by the economic slowdown or meet the equity margin requirements; entitlement was subject to approval by higher authorities, not automatic.
  • Subsidiary Ledgers: The entries were presumed regular and correct under banking practices and GAAP, and petitioners failed to rebut this presumption.
  • Deficiency Claim: After recomputation applying only the valid interest rates (19.5%/21.5% then 12%), eliminating penalties and other charges, applying payments to interest first then principal, and pro-rating payments among the three notes, the Court found no deficiency. Instead, petitioners overpaid by P3,686,101.52.
  • Joint and Solidary Agreement: The spouses Dee were held to be sureties (not guarantors) solidarily liable under Article 2047 of the Civil Code, but only up to the extent of the valid obligation, which after proper computation resulted in a credit in their favor rather than a debt.
  • Foreclosure Validity: The extrajudicial foreclosure and auction sale were declared valid, but PNB was ordered to refund the surplus/overpayment of P3,686,101.52 plus legal interest.

• Mutuality of Contracts (Article 1308, Civil Code) — The contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. The Court applied this to invalidate escalation clauses that allowed the bank to unilaterally increase interest rates without borrower consent, as such clauses made fulfillment dependent exclusively on the lender's will.
• Contracts of Adhesion (Contra Proferentem) — Standardized contracts prepared by the stronger party (bank) where the weaker party (borrower) has no bargaining power and can only "take it or leave it" must be construed strictly against the party who caused it (the bank). Ambiguities are resolved against the drafter.
• Truth in Lending Act (RA 3765) — Banks must fully disclose the true cost of credit to borrowers before the consummation of the transaction. Charges not revealed in disclosure statements, even if stipulated in promissory notes, cannot be given effect, as the law aims to protect citizens from lack of awareness of the true cost of credit.
• Unconscionable Interest Rates — Although the Usury Law (Act 2655) has been effectively repealed by CB Circular 905, courts retain the authority to reduce iniquitous, unconscionable, and exorbitant rates charged for the use of money to prevent the economic ruin of borrowers.
• Suretyship vs. Guaranty (Article 2047, Civil Code) — A surety binds himself solidarily with the principal debtor, undertaking to pay if the principal debtor does not pay, while a guarantor is a collateral undertaking. The spouses were held to be sureties under the JSA, making them jointly and severally liable with NSBCI.
• Application of Payments (Articles 1252-1254, Civil Code) — Payments are applied to debts already due; interests are paid before the principal; and payments are proportionately applied to interests of the same nature and burden when there are multiple debts.

• "Courts have the authority to strike down or to modify provisions in promissory notes that grant the lenders unrestrained power to increase interest rates, penalties and other charges at the latter’s sole discretion and without giving prior notice to and securing the consent of the borrowers."
• "This unilateral authority is anathema to the mutuality of contracts and enable lenders to take undue advantage of borrowers."
• "The 'unilateral determination and imposition' of increased rates is 'violative of the principle of mutuality of contracts ordained in Article 1308 of the Civil Code.'"
• "The time is now ripe to give teeth to the often ignored forty-one-year old 'Truth in Lending Act' and thus transform it from a snivelling paper tiger to a growling financial watchdog of hapless borrowers."
• "Rates found to be iniquitous or unconscionable are void, as if it there were no express contract thereon."
• "It would be the zenith of farcicality to specify and agree upon rates that could be subsequently upgraded at whim by only one party to the agreement."

• Philippine National Bank v. Court of Appeals (196 SCRA 536, April 30, 1991 and 238 SCRA 20, November 8, 1994) — Cited for the principle that neither CB Circular 905 nor PD 1684 authorized either party to unilaterally raise interest rates without the other's consent; escalation clauses must be based on reasonable and valid grounds, not solely potestative.
• Spouses Florendo v. Court of Appeals (333 Phil. 535, December 17, 1996) — Cited for the prohibition against unilateral determination of contract terms and the invalidity of clauses that make fulfillment dependent on one party's will.
• Spouses Almeda v. Court of Appeals (326 Phil. 309, April 17, 1996) — Cited regarding the "unilateral and lopsided policy" of increasing interest rates without prior assent of the borrower.
• Spouses Solangon v. Salazar (412 Phil. 816, June 29, 2001) — Cited for the rule that iniquitous or unconscionable interest rates must be equitably reduced.
• Consolidated Bank and Trust Corp. (Solidbank) v. Court of Appeals (316 Phil. 247, July 14, 1995) — Cited for the effect of non-disclosure under the Truth in Lending Act: charges not disclosed cannot be collected.
• Garcia v. Rita Legarda, Inc. (128 Phil. 590, October 30, 1967) — Cited for the principle that fulfillment dependent exclusively on the uncontrolled will of one party is void.

• Article 1308, Civil Code — Mutuality of contracts; validity or compliance cannot be left to the will of one party.
• Article 1956, Civil Code — No interest shall be due unless expressly stipulated in writing.
• Article 1377, Civil Code — Interpretation of obscure words or stipulations against the party who caused the obscurity (contra proferentem).
• Article 2047, Civil Code — Definition of suretyship as a solidary obligation distinct from guaranty.
• Article 2208, Civil Code — Attorney's fees as damages; courts may determine reasonableness based on quantum meruit.
• Article 2227, Civil Code — Liquidated damages shall be equitably reduced if they are iniquitous or unconscionable.
• Articles 1252, 1253, and 1254, Civil Code — Rules on application of payments (to debts already due, interest before principal, pro-ration among debts of same nature).
• Article 1959, Civil Code — No capitalization of interest unless stipulated (simple interest computation).
• Article 1960, Civil Code — Solutio indebiti (payment by mistake) requiring return of excess payment.
• Republic Act No. 3765 (Truth in Lending Act) — Disclosure requirements; policy of the State to protect citizens from lack of awareness of the true cost of credit.
• Act No. 3135, as amended — Extra-judicial foreclosure of real estate mortgage.
• Republic Act No. 8791 (General Banking Law of 2000) — Safe and sound banking practices; conditions for loan renewals and extensions subject to Monetary Board regulation.
• Central Bank Circular No. 905 — Lifted interest rate ceilings under the Usury Law but did not authorize unilateral increases by lenders.
• Central Bank Circular No. 416 — Established the legal interest rate of 12% per annum on loans and forbearance of money.

• N/A (Justices Sandoval-Gutierrez and Carpio-Morales concurred in the result without separate opinions).