Tan vs. Court of Appeals

Penalty charges or compensatory interest on loans may accrue interest through compounding if there is an express stipulation in the contract allowing such compounding, pursuant to Article 1959 of the New Civil Code; however, courts may equitably reduce penalties under Article 1229 when the debtor has made partial payments and demonstrated good faith.

• On May 14, 1978 and July 6, 1978, petitioner Antonio Tan obtained two loans from respondent Cultural Center of the Philippines (CCP) in the total principal amount of Four Million Pesos (P4,000,000.00), evidenced by two promissory notes with maturity dates on May 14, 1979 and July 6, 1979, respectively.
• After defaulting on the original loans and making partial payments, petitioner had the loans restructured and executed a promissory note (Exhibit "A") on August 31, 1979 in the amount of Three Million Four Hundred Eleven Thousand Four Hundred Twenty-One Pesos and Thirty-Two Centavos (P3,411,421.32) payable in five installments, with the last installment due on December 31, 1980.
• Petitioner failed to pay any installment on the restructured loan and sent letters dated January 26, 1982 and October 20, 1983 requesting alternative payment schemes and a moratorium, respectively, to which respondent CCP did not favorably respond.
• On May 30, 1984, respondent CCP, through counsel, wrote a letter demanding full payment of the restructured loan which as of April 30, 1984 amounted to Six Million Eighty-Eight Thousand Seven Hundred Thirty-Five Pesos and Three Centavos (P6,088,735.03).
• On August 29, 1984, respondent CCP filed a complaint for collection of a sum of money in the RTC of Manila, docketed as Civil Case No. 84-26363, after petitioner failed to settle his obligation.
• During the pendency of the case, petitioner filed a Manifestation proposing to settle his indebtedness through a down payment and installment payments, which respondent CCP did not accept.
• Petitioner made partial payments totaling Four Hundred Fifty-Two Thousand Five Hundred Sixty-One Pesos and Forty-Three Centavos (P452,561.43) during the period from May 13, 1983 to September 30, 1983.
• As of August 28, 1986, petitioner's outstanding account consisted of Principal: P2,838,454.68; Interest: P576,167.89; and Surcharge: P4,581,692.10, totaling P7,996,314.67.

• There is no contractual or legal basis for compounding interest on surcharges because the promissory note does not provide for it and the New Civil Code contains no provision allowing imputation of interest on surcharges.
• The Court of Appeals erred in not suspending the imposition of interest for the period when private respondent failed to assist petitioner in applying for relief of liability through the Commission on Audit and the Office of the President, allegedly making the obligation conditional on the approval of the application.
• The penalty should be reduced to ten percent (10%) of the unpaid debt pursuant to Bachrach Motor Company v. Espiritu, considering that petitioner made partial payments showing good faith.
• Attorney's fees should be totally eliminated and penalties reduced considering petitioner's partial payments and financial difficulties.

• The promissory note expressly provides for the imposition of both interest and penalties in case of default, including a stipulation that any interest due if not paid shall be added to the total amount and bear interest.
• The letter dated September 28, 1988 allegedly promising assistance in applying for relief was not formally offered as evidence in the trial court and cannot be considered pursuant to Rule 132, Section 34 of the Rules of Court.
• Even if the letter were considered, it contained no categorical agreement suspending the payment of interest and surcharge during the processing of the application for condonation.
• It was the primary responsibility of petitioner, not respondent CCP, to inform the Commission on Audit and the Office of the President of his application for condonation.

• Procedural Issues:
  • Whether the letter dated September 28, 1988 allegedly sent by respondent CCP to petitioner can be considered as evidence despite not having been formally offered in the trial court.
• Substantive Issues:
  • Whether there are contractual and legal bases for the imposition of penalty, interest on the penalty (compounding), and attorney's fees.
  • Whether the running of interest and surcharge was suspended by respondent CCP's promise to assist petitioner in applying for relief through the Commission on Audit and the Office of the President.
  • Whether the penalty charges should be reduced and attorney's fees eliminated considering petitioner's partial payments and good faith.

• Procedural:
  • The letter dated September 28, 1988 cannot be considered as evidence because it was not formally offered by either party in the trial court, and pursuant to Rule 132, Section 34 of the Rules of Court, the court shall consider no evidence which has not been formally offered.
  • Even if considered, the letter does not contain any categorical agreement on the part of respondent CCP that the payment of interest and surcharge is deemed suspended while the appeal for condonation was being processed.
• Substantive:
  • There is contractual basis for the imposition of interest and penalties: the promissory note expressly provides for 14% per annum monetary interest and 2% per month penalty charge, and contains a stipulation permitting the compounding of interest ("Any interest which may be due if not paid shall be added to the total amount when due and shall become part thereof, the whole amount to bear interest").
  • Penalty clauses can be in the form of penalty or compensatory interest, and the compounding of such penalty interest is sanctioned by Article 1959 of the New Civil Code which allows parties to stipulate that unpaid interest shall be capitalized and earn new interest.
  • The running of interest and surcharge was not suspended; it was the primary responsibility of petitioner to bring his administrative appeal for condonation to the attention of the Commission on Audit and the Office of the President.
  • Pursuant to Article 1229 of the New Civil Code, the penalty charge of 2% per month on the total amount due, compounded monthly, is reduced to a straight 12% per annum on the total amount due starting August 28, 1986, considering petitioner's partial payments, offers to compromise, and good faith, although the deprivation of respondent's use of money for a long period was also considered.
  • The award of 5% attorney's fees is affirmed as just and correct, given that respondent was represented by a government lawyer and the original award of 25% was excessive.

• Distinction between monetary interest and penalty interest — Monetary interest constitutes compensation for the use of money borrowed, while penalty interest or compensatory interest is the penalty for delay in payment; they are separate and distinct from each other and may be demanded separately if the parties so stipulate.
• Compounding of interest on penalties — Pursuant to Article 1959 of the New Civil Code, interest due and unpaid shall not earn interest unless the contracting parties stipulate to capitalize the interest; this provision applies to penalty interest, allowing the compounding of penalties if expressly agreed upon in the contract.
• Equitable reduction of penalties (Article 1229, New Civil Code) — The judge shall equitably reduce the penalty when the principal obligation has been partly or irregularly complied with by the debtor, or even if there has been no performance, if the penalty is iniquitous or unconscionable; partial payments and the debtor's good faith are valid grounds for reduction.
• Formal offer of evidence (Rule 132, Section 34) — The court shall consider no evidence which has not been formally offered; documents not formally offered cannot be given weight or considered in the adjudication of the case.

• "The stipulated fourteen percent (14%) per annum interest charge until full payment of the loan constitutes the monetary interest on the note... On the other hand, the stipulated two percent (2%) per month penalty is in the form of penalty charge which is separate and distinct from the monetary interest on the principal of the loan." — This quote establishes the fundamental distinction between monetary interest and penalty interest, allowing their separate accumulation.
• "Penalty clauses can be in the form of penalty or compensatory interest. Thus, the compounding of the penalty or compensatory interest is sanctioned by and allowed pursuant to the above-quoted provision of Article 1959 of the New Civil Code." — This passage clarifies that penalty charges may themselves earn interest if the parties contractually agree to such compounding.
• "Inasmuch as the said stipulation on the compounding of interest has the force of law between the parties and does not appear to be inequitable or unjust, the said written stipulation should be respected." — This emphasizes the binding nature of contractual stipulations on compounding interest when freely agreed upon by the parties.
• "Considering petitioner's several partial payments and the fact he is liable under the note for the two percent (2%) penalty charge per month on the total amount due, compounded monthly, for twenty-one (21) years since his default in 1980, we find it fair and equitable to reduce the penalty charge to a straight twelve percent (12%) per annum on the total amount due." — This illustrates the application of Article 1229 allowing equitable reduction of penalties when they become unconscionable despite the debtor's partial compliance and good faith.

• Government Service Insurance System v. Court of Appeals — Cited for the rule that the New Civil Code permits an agreement upon a penalty apart from the monetary interest, and that the two are different and distinct from each other and may be demanded separately if stipulated.
• Equitable Banking Corp. v. Liwanag — Cited for the principle that a stipulation about payment of an additional interest rate partakes of the nature of a penalty clause which is sanctioned by law under Article 2209 of the New Civil Code.
• National Power Corporation v. National Merchandising Corporation — Distinguished from the present case; the ruling that imposition of interest on damages is unjust in prolonged litigation through no fault of the defendant is not applicable where there is an express contractual stipulation on compounding of interest.
• Bachrach Motor Company v. Espiritu — Cited by petitioner for the proposition that penalty should be reduced to 10% of the unpaid debt; the Court found reduction justified under Article 1229 but not necessarily to 10%.

• Article 1159 of the New Civil Code — Obligations arising from contracts have the force of law between the contracting parties and should be complied with in good faith.
• Article 1226 of the New Civil Code — In obligations with a penal clause, the penalty shall substitute the indemnity for damages and the payment of interests in case of non-compliance, if there is no stipulation to the contrary.
• Article 1229 of the New Civil Code — The judge shall equitably reduce the penalty when the principal obligation has been partly or irregularly complied with by the debtor; the penalty may also be reduced if it is iniquitous or unconscionable.
• Article 1956 of the New Civil Code — No interest shall be due unless it has been expressly stipulated in writing.
• Article 1959 of the New Civil Code — Interest due and unpaid shall not earn interest unless the contracting parties by stipulation capitalize the interest due and unpaid, which as added principal, shall earn new interest.
• Article 2209 of the New Civil Code — If the obligation consists in the payment of a sum of money, and the debtor incurs in delay, the indemnity for damages shall be the payment of the interest agreed upon, or legal interest in the absence of stipulation.
• Article 2212 of the New Civil Code — Interest due shall earn legal interest from the time it is judicially demanded, although the obligation may be silent upon this point.
• Rule 132, Section 34 of the Rules of Court — The court shall consider no evidence which has not been formally offered.
• Central Bank Circular 416, Series of 1974 — Prescribed the rate of interest for the loan or forbearance of money in the absence of express contract as twelve (12%) per cent per annum.