Pryce Corporation vs. Philippine Amusement and Gaming Corporation

A contractual stipulation requiring a defaulting lessee to pay rentals for the remaining term of the lease upon the lessor's termination of the contract constitutes a valid penalty clause, which courts may equitably reduce if iniquitous or unconscionable under Articles 1229 and 2227 of the Civil Code.

Representatives of Pryce Properties Corporation (PPC) and the Philippine Amusement and Gaming Corporation (PAGCOR) negotiated in early 1992 to establish a casino in Pryce Plaza Hotel in Cagayan de Oro City. On November 11, 1992, the parties executed a three-year Contract of Lease, with an addendum on November 13, 1992. Despite local government opposition, including resolutions and ordinances banning casinos, PAGCOR advertised the casino's opening for December 18, 1992. Hours before the opening, a public rally and barricades forced the suspension of operations. PAGCOR briefly resumed operations in July 1993 but indefinitely suspended them upon the advice of the Office of the President, ceasing operations prior to September 1993.

• Negotiation and Execution of Lease: In early 1992, PPC and PAGCOR negotiated the establishment of a casino in Cagayan de Oro City. Following consultations with local officials who expressed that opposition was surmountable, the parties executed a Contract of Lease on November 11, 1992, for a three-year term starting December 1, 1992. An addendum was executed on November 13, 1992, leasing additional space for casino personnel.
• Local Opposition and Rallies: The Sangguniang Panlungsod had previously passed resolutions banning casinos (Resolution No. 2295 in 1990 and Resolution No. 2675 in 1992). On December 7, 1992, Ordinance No. 3353 was enacted, prohibiting the issuance of business permits for casino operations. Hours before the casino's formal opening on December 18, 1992, a public rally and barricades forced PAGCOR to suspend operations. Operations briefly resumed on July 15, 1993, but were again met with rallies.
• Legal Challenges to Ordinances: On January 7, 1993, PPC filed a Petition for Prohibition against the city and mayor in the Court of Appeals, which PAGCOR intervened in. The CA declared Ordinance Nos. 3353 and 3375-93 unconstitutional on March 31, 1993. The Supreme Court affirmed this ruling in G.R. No. 111097 on July 20, 1994.
• Cessation of Operations and Demands: Upon verbal advice from the Office of the President, PAGCOR stopped casino operations prior to September 1993. PPC demanded payment of accrued rentals for September to November 1993 and stated its board's decision to collect full rentals in case of pre-termination. PAGCOR refused, citing unforeseen circumstances, and demanded a refund of its advanced rental deposits and expenses for parking lot improvements.
• Termination of Contract: On November 25, 1993, PPC informed PAGCOR that it was terminating the contract due to PAGCOR's continuing breach, exercising its rights under Article XX(a) and (c) of the Contract of Lease.

• Validity of Penalty Clause: Petitioner argued that Sections 20(a) and 20(c) of the Contract of Lease, granting the lessor the right to terminate for cause and collect rentals for the remaining term, are valid and binding.
• Termination vs. Rescission: Petitioner maintained that the remedy availed of was termination under the contract, not rescission under Article 1659 of the Civil Code, and that the two concepts carry different legal consequences.
• Inapplicability of Rios v. Jacinto: Petitioner argued that Rios v. Jacinto Palma Enterprises, which denied a lessor future rentals, involved rescission and is thus inapplicable to a case involving termination.
• Harmonization of Law and Contract: Petitioner insisted that Article 1659 of the Civil Code and Article 20 of the Contract can be harmonized, as the law is deemed written into contracts, but does not supersede valid contractual stipulations.

• Application of Article 1659: Respondent countered that Article 1659 of the Civil Code governs the dispute, and having chosen to rescind the contract, PPC is no longer entitled to future rentals.
• Justification for Pre-termination: Respondent argued that there were valid, justifiable, and good reasons for pre-terminating the lease due to relentless public opposition and the advice of the Office of the President, which constituted unforeseen legal and practical circumstances.
• Right to Reimbursement: Respondent maintained that PPC is liable for the reimbursement of PAGCOR's cash deposits and the value of permanent improvements made to the hotel's parking lot.

• Nature of Remedy: Whether the remedy availed of by PPC was termination under the contract or rescission under Article 1659 of the Civil Code.
• Validity of Penalty Clause: Whether the stipulation in Section XX(c) of the Contract of Lease, requiring the lessee to pay rentals for the remaining term upon termination, is a valid and binding penalty clause.
• Reduction of Penalty: Whether the penalty clause requiring payment of future rentals amounting to P7,037,835.40 may be equitably reduced by the courts.

• Nature of Remedy: The remedy was termination, not rescission. Rescission (or resolution) declares the contract void ab initio and requires mutual restitution to restore the parties to their status quo ante. Termination ends the contract moving forward, recognizing its validity prior to cancellation and enforcing accrued obligations. PPC's demand for accrued rentals for September to November 1993 demonstrated an intent to partially enforce the contract prior to its cancellation, which is inconsistent with rescission.
• Validity of Penalty Clause: Section XX(c) constitutes a valid penal clause intended to insure the performance of the obligation. Obligations arising from contracts have the force of law between the parties, and courts are not authorized to make or modify contracts or rescue parties from disadvantageous stipulations, provided they are not contrary to law, morals, good customs, public order, or public policy. The stipulation requiring payment of remaining rentals upon breach and termination is a common accessory obligation that functions as liquidated damages. Because Article XX(c) also stipulates liability for actual or consequential damages, the exception in Article 1226, paragraph 1 of the Civil Code applies, allowing the obligee to recover both the penalty and other damages.
• Reduction of Penalty: The penalty was equitably reduced. While the stipulated penalty is valid, Articles 1229 and 2227 of the Civil Code explicitly sanction the equitable reduction of penalties when they are iniquitous or unconscionable. PAGCOR's breach was occasioned by real and pressing events—not fortuitous in law, but involving intense local opposition, costly litigation, and presidential advice to cease operations. PAGCOR suffered tremendous loss of expected revenues and fully operated for only a limited time. Consequently, the claim for future rentals amounting to P7,037,835.40 was deemed highly iniquitous and was reduced to P687,289.50, equivalent to PAGCOR's advanced rental deposits.

• Distinction between Termination and Rescission — Termination refers to the end of a contract, usually before the anticipated term, where the contract is deemed valid at inception and binding until the moment of cancellation; parties are obliged to comply with accrued obligations but are released from future ones. Rescission (or resolution) declares a contract void from the beginning, requiring mutual restitution to restore the parties to their status quo ante as if the contract never existed.
• Autonomy of Contracts and Validity of Penalty Clauses — Parties are free to stipulate terms, clauses, and conditions they deem convenient, including penal clauses that insure performance and provide for liquidated damages. Such stipulations have the force of law between the parties and are binding as long as they are not contrary to law, morals, good customs, public order, or public policy. Courts cannot modify contracts or rescue parties from disadvantageous provisions.
• Equitable Reduction of Penalties — Courts are empowered to equitably reduce stipulated penalties or liquidated damages if they are iniquitous or unconscionable, pursuant to Articles 1229 and 2227 of the Civil Code. Factors to consider include the type, extent, and purpose of the penalty; the nature of the obligation; the mode of the breach and its consequences; the supervening realities; and the standing and relationship of the parties.

• "In legal contemplation, the termination of a contract is not equivalent to its rescission. When an agreement is terminated, it is deemed valid at inception. Prior to termination, the contract binds the parties, who are thus obliged to observe its provisions. However, when it is rescinded, it is deemed inexistent, and the parties are returned to their status quo ante."
• "To rescind is to declare a contract void in its inception and to put an end to it as though it never were. It is not merely to terminate it and release parties from further obligations to each other but to abrogate it from the beginning and restore the parties to relative positions which they would have occupied had no contract ever been made."
• "The termination or cancellation of a contract would necessarily entail enforcement of its terms prior to the declaration of its cancellation in the same way that before a lessee is ejected under a lease contract, he has to fulfill his obligations thereunder that had accrued prior to his ejectment."

• Universal Food Corporation v. CA, 144 Phil. 1 (1970) — Followed regarding the distinction between rescission due to breach of faith under Article 1191 and rescission due to lesion or economic prejudice under Article 1381.
• Huibonhoa v. CA, 378 Phil. 386 (1999) — Followed for the distinction between cancellation/termination and rescission, establishing that seeking rental arrearages constitutes partial enforcement rather than rescission.
• Rios v. Jacinto Palma Enterprises, 49 Phil. 7 (1926) — Distinguished; the remedy in that case was rescission under Article 1659, not termination, which is why the lessor was not entitled to future rentals.

• Article 1159, Civil Code — Obligations arising from contracts have the force of law between the contracting parties and should be complied with in good faith. Applied to enforce the contractual stipulations agreed upon by PPC and PAGCOR.
• Article 1306, Civil Code — Allows the parties to establish stipulations, clauses, terms, and conditions they deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy. Applied to uphold the validity of the penalty clause.
• Article 1659, Civil Code — Authorizes the aggrieved party in a lease contract to ask for rescission and indemnification for damages, or only the latter. Distinguished from the contractual right of termination invoked by PPC.
• Article 1226, paragraph 1, Civil Code — Governs obligations with a penal clause, where the penalty generally substitutes for indemnity for damages, except when there is a stipulation to the contrary, the obligor refuses to pay the penalty, or the obligor is guilty of fraud. Applied to allow recovery of both the penalty and other damages because the contract stipulated liability for both remaining rentals and actual or consequential damages.
• Article 1229, Civil Code — Authorizes judges to equitably reduce the penalty when the principal obligation has been partly or irregularly complied with, or if the penalty is iniquitous or unconscionable. Applied to reduce the future rentals penalty.
• Article 2227, Civil Code — Mandates the equitable reduction of liquidated damages, whether intended as an indemnity or a penalty, if they are iniquitous or unconscionable. Applied in conjunction with Article 1229 to reduce the penalty.

Sandoval-Gutierrez, Corona, Carpio-Morales, and Garcia, JJ.