Philippine Savings Bank vs. Castillo and Capati

A stipulation in a loan agreement that empowers the creditor to unilaterally increase or decrease the interest rate without the debtor’s consent is void for violating the principle of mutuality of contracts under Article 1308 of the Civil Code, and any rate increase imposed without such consent is unenforceable; the debtor’s silence upon receiving notice of an increase, or a request for reduction, does not constitute consent.

Respondent spouses Alfredo M. Castillo and Elizabeth Capati-Castillo and respondent spouses Romeo B. Capati and Aquilina M. Lobo were registered owners of two lots in Tondo, Manila. In May 1997 they obtained a ₱2,500,000.00 loan from petitioner Philippine Savings Bank, secured by real estate mortgages over their properties. The promissory note contained an escalation clause allowing the bank to review and adjust the interest rate every 90 days, and a provision stating that the rate could be increased or decreased as the bank might prescribe. Between 1997 and 1999, the bank repeatedly adjusted the rate — at one point reaching 29% per annum — and notified respondents of each change. Respondent Alfredo Castillo sent several letters requesting a reduction of the rates, but never expressly assented to the increases. After respondents defaulted in December 1999, the bank foreclosed extrajudicially; the properties were sold at auction and awarded to the bank as the sole bidder. Respondents subsequently sued to nullify the foreclosure and to recover damages, assailing the unilateral interest adjustments.

• The Loan and Promissory Note: On May 7, 1997, respondents obtained a ₱2,500,000.00 loan from petitioner bank, secured by real estate mortgages over two parcels of land in Tondo, Manila. The Promissory Note stipulated interest at 17% per annum, payable in 59 monthly installments with a balloon payment on May 7, 2002. It further provided that “the rate of interest herein provided shall be subject to review and/or adjustment every ninety (90) days” and that “the rate of interest and/or bank charges … may be increased, decreased or otherwise changed from time to time … as the PHILIPPINE SAVINGS BANK may prescribe for its debtors.”

• Escalation Clause and Rate Adjustments: From May 1997 to December 1999, the bank repeatedly increased and decreased the interest rate — the highest being 29% per annum and the lowest 15.5% per annum. Respondents were notified in writing of each change but neither gave their written confirmation nor formally questioned the increases.

• The “Conformity Letter” on Review Period: Exhibits presented during trial showed that respondents had signed a conformity letter amending the interest rate review period from 90 days to 30 days. The bank argued this demonstrated their acquiescence to rate adjustments.

• Requests for Reduction: Respondent Alfredo Castillo sent several letters to the bank requesting a reduction of the interest rates. In those letters, he explicitly compared the bank’s rates unfavorably with those of other financial institutions and stated that the high rates placed the company in a critical financial condition.

• Default and Foreclosure: Respondents ceased paying amortizations in December 1999. The bank sent demand letters, and upon non-payment, initiated an extrajudicial foreclosure sale on June 16, 2000. The properties were sold for ₱2,778,611.27 and awarded to the bank as the only bidder; the certificate of sale was registered with the Registry of Deeds of Manila on July 3, 2000.

• Respondents’ Action: Respondents failed to redeem within the one-year redemption period. Alfredo Castillo later requested a 60-day extension to redeem, but this was not pursued. On October 1, 2001, respondents filed a complaint for reformation, annulment of the foreclosure, and damages, alleging that the unilateral interest increases were void and that the foreclosure was consequently invalid.

• Consent to Interest Rate Adjustments: Petitioner argued that respondents acquiesced to the modified rates because they received written notices of every change and never objected. It further asserted that the letters requesting rate reductions manifested respondents’ recognition of the rates’ validity, not their repudiation.

• Mutuality Not Violated: Petitioner contended that the contractual provision was not one-sided because the promissory note contained a de-escalation clause and the bank had, on several occasions, lowered the interest rates. It claimed that the uniformity of notices sent and the respondents’ repeated requests for reduction confirmed the legality of the imposed rates.

• No Basis for Damages: Petitioner maintained that the award of moral and exemplary damages and attorney’s fees was improper because it acted in good faith, enforcing contractual stipulations without fraud or malevolence. The imposition of rate adjustments was attributed to compliance with the loan agreement.

• Violation of Mutuality of Contracts: Respondents countered that the unilateral increases in interest rates contravened Article 1308 of the Civil Code because the promissory note left rate adjustments solely to the bank’s will. They asserted that their silence on the notification memos could not substitute for express consent, and that the letters requesting reduction were in fact protests against the high rates rather than acceptance of them.

• Entitlement to Damages: Respondents claimed that the arbitrary imposition of exorbitant interest rates and the consequent foreclosure caused mental anguish and besmirched reputation, justifying moral and exemplary damages as well as attorney’s fees.

• Validity of Unilateral Interest Rate Adjustments: Whether the CA correctly held that the bank’s unilateral increases in interest rates were unreasonable and void for want of the borrowers’ consent, thereby violating the principle of mutuality of contracts.

• Award of Damages and Attorney’s Fees: Whether the CA properly sustained the award of moral damages, exemplary damages, and attorney’s fees absent any finding of fraud, bad faith, or wanton disregard of contractual obligations on the part of the bank.

• Validity of Unilateral Interest Rate Adjustments: The unilateral increases were void. Article 1308 of the Civil Code mandates that the validity and compliance of a contract cannot be left to the will of one party. The promissory note allowed the bank to alter the interest rate at its sole discretion without requiring the maker’s conformity, thereby violating mutuality. Respondents’ silence upon receiving notification memos did not constitute assent, because no one receiving a proposal to change a contract is obliged to answer the proposal. The letters requesting reduction did not signify consent to the imposed rates; they expressly questioned the propriety of those rates and demonstrated dissatisfaction, not ratification. The existence of a de-escalation clause did not cure the defect; any upward or downward adjustment still required mutual agreement. Accordingly, the adjusted rates beyond the original 17% per annum were unenforceable, and the order for refund of excess interest paid was proper.

• Award of Damages and Attorney’s Fees: The awards were deleted. Moral damages are recoverable for breach of contract only when the breach is attended by fraud, bad faith, or wanton disregard of contractual obligations. The bank’s unilateral imposition of rate increases, while legally erroneous, amounted to bad business judgment or simple negligence, not a dishonest purpose or conscious wrongdoing. Respondents failed to prove that the bank acted with malevolent intent or fraud. Hence, neither moral nor exemplary damages could be sustained, and the corresponding attorney’s fees and litigation expenses were likewise unwarranted. However, the refund of interest payments in excess of 17% per annum must earn legal interest at 12% per annum from the date of the filing of the complaint until full satisfaction, pursuant to Eastern Shipping Lines, Inc. v. Court of Appeals.

• Principle of Mutuality of Contracts (Article 1308, Civil Code) — Contracts must bind both contracting parties; their validity or compliance cannot be left to the will of one. When a loan agreement vests in the creditor the sole power to increase interest rates without the debtor’s consent, that stipulation is void, and any increase imposed by the creditor is unenforceable.

• No Duty to Reply to a Proposal to Modify a Contract — An offeree’s silence or inaction in response to a proposed contract modification does not amount to acceptance; no one receiving a proposal is obliged to answer it. This applies to notifications of interest rate changes sent by a creditor to a debtor.

• Request for Reduction Is Not Ratification — A debtor’s plea for a lower interest rate does not signal consent to the existing rate; it is, instead, a challenge to its propriety and an expression of dissatisfaction.

• De-escalation Clause Does Not Cure Unilateral Escalation — The inclusion of a de-escalation clause, while consistent with the requirement of Banco Filipino Savings and Mortgage Bank v. Judge Navarro, does not legitimize unilateral upward adjustments. Any change in the interest rate — upward or downward — remains subject to the mutual consent of the contracting parties.

• Moral and Exemplary Damages in Breach of Contract — Moral damages are not recoverable simply because a contract is breached. There must be fraud, bad faith, or wanton disregard of contractual obligations. Bad faith entails a dishonest purpose or conscious wrongdoing; mere bad business judgment or negligence is insufficient. Exemplary damages equally require a fraudulent or malevolent act.

• Legal Interest on Refund of Excess Interest Payments — When a party is ordered to refund a sum of money because the interest collected was illegally imposed, the amount bears interest at 12% per annum from the time of judicial demand (the filing of the complaint) until full satisfaction, following Eastern Shipping Lines, Inc. v. Court of Appeals.

• “The unilateral determination and imposition of the increased rates is violative of the principle of mutuality of contracts under Article 1308 of the Civil Code, which provides that ‘[t]he contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them.’”
• “Any contract which appears to be heavily weighed in favor of one of the parties so as to lead to an unconscionable result, thus partaking of the nature of a contract of adhesion, is void. Any stipulation regarding the validity or compliance of the contract left solely to the will of one of the parties is likewise invalid.”
• “As we have held, no one receiving a proposal to change a contract is obliged to answer the proposal.”
• “Basic is the rule that there can be no contract in its true sense without the mutual assent of the parties. … Similarly, contract changes must be made with the consent of the contracting parties. The minds of all the parties must meet as to the proposed modification, especially when it affects an important aspect of the agreement. In the case of loan contracts, the interest rate is undeniably always a vital component.”
• “The validity of the escalation clause did not give petitioner the unbridled right to unilaterally adjust interest rates. The adjustment should have still been subjected to the mutual agreement of the contracting parties.”
• “Moral damages are not recoverable simply because a contract has been breached. They are recoverable only if the party from whom it is claimed acted fraudulently or in bad faith or in wanton disregard of his contractual obligations. The breach must be wanton, reckless, malicious or in bad faith, and oppressive or abusive.”

• Banco Filipino Savings and Mortgage Bank v. Judge Navarro, 236 Phil. 370 (1987) — Established that escalation clauses are valid only when accompanied by a corresponding de-escalation clause. Applied to stress that the mere presence of a de-escalation clause did not authorize unilateral rate increases without mutual consent.
• Philippine National Bank v. Court of Appeals, 328 Phil. 54 (1996) — Ruled that non-response to a proposal to modify a contract does not constitute acceptance. Followed to reject the argument that the borrowers’ silence amounted to consent.
• Eastern Shipping Lines, Inc. v. Court of Appeals, G.R. No. 97412, July 12, 1994, 234 SCRA 78 — Prescribed the rule on legal interest for monetary obligations arising from breach, fixing the rate at 12% per annum from judicial demand. Applied to impose interest on the refund of excess interest payments.
• Philippine National Bank v. Rocamora, G.R. No. 164549, September 18, 2009, 600 SCRA 395 — Reiterated that moral and exemplary damages in breach of contract require a showing of fraud or bad faith. Relied upon to delete the damages awards.

• 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.” Applied to nullify the unilateral interest escalation because the promissory note allowed the bank to change the interest rate at its sole discretion without the borrowers’ conformity.
• Articles 2217, 2220, 2231 of the Civil Code (in relation to moral and exemplary damages) — Applied as general principles governing the recovery of moral and exemplary damages, requiring proof of bad faith or malevolence beyond mere breach of contract.

Antonio T. Carpio, Diosdado M. Peralta, Roberto A. Abad, Jose Catral Mendoza.