Vasquez vs. Philippine National Bank

A loan interest rate scheme that leaves the determination or modification of interest rates to the lender’s sole discretion, without a market-based reference rate agreed upon in writing and without prior notice to and consent of the borrower, is void for violating the principle of mutuality of contracts under Article 1308 of the Civil Code. The void interest stipulation is deemed not written, but the principal obligation remains; because the debtor cannot be considered in default for failing to pay illegal interest, the foreclosure sale is invalid.

Vasquez obtained two loans from PNB under the Pangkabuhayan ng Bayan Program and the Revolving Credit Line, secured by a real estate mortgage over four parcels of land in Trece Martirez, Cavite, covered by Transfer Certificates of Title Nos. 295114, 295115, 322380, and 322381. The parties executed a Credit Agreement dated November 8, 1996, with General Conditions (For Individual Borrower) attached as Annex “A,” and the loans were evidenced by PN 009/96PNB and PN 031/96RCL. The loan documents contained provisions on interest and penalties, and the mortgage authorized extrajudicial foreclosure under Act No. 3135, as amended.

On November 8, 1996, Engr. Ricardo O. Vasquez obtained from Philippine National Bank (PNB) a loan of P600,000.00 under the Pangkabuhayan ng Bayan Program, evidenced by Promissory Note No. 009/96PNB, and another loan of P800,000.00 under a Revolving Credit Line, evidenced by Promissory Note No. 031/96RCL. The total obligation of P1,400,000.00 was secured by a Real Estate Mortgage over four parcels of land located in Trece Martirez, Cavite, covered by Transfer Certificates of Title Nos. 295114, 295115, 322380, and 322381 and registered in Vasquez’s name. The parties also executed a Credit Agreement dated November 8, 1996, with General Conditions (For Individual Borrower) attached as Annex “A.” PNB later asserted that the Pangkabuhayan Loan carried a stipulated interest rate of 16.5% per annum fixed for one year and the Revolving Credit Line carried 18% per annum. The loan documents, however, did not clearly fix those rates: the Credit Agreement stated for the Pangkabuhayan Loan an interest rate of “Prime Rate plus Spread [i]nterest rate,” the Revolving Credit Line proviso on interest was left blank, and both promissory notes referred only to an “applicable” interest rate. The Credit Agreement and related documents further allowed PNB to increase or decrease the interest rate at any time depending on whatever policy it might adopt in the future, based on changes in its cost of money or overall cost of funds, with PNB’s determination of the amount of interest payable deemed conclusive and binding absent manifest error; the Real Estate Mortgage similarly allowed the rate to be increased as PNB’s Board of Directors might prescribe.

On September 22, 1998, PNB extrajudicially demanded payment of the loans, relying on a Statement of Account as of September 15, 1998. The Statement of Account showed that PNB had imposed varying interest rates. For the Pangkabuhayan Loan, the rate was increased from 16%, applied from August 7, 1997 to November 7, 1997, to 33%, applied from November 7, 1997 to September 15, 1998. For the Revolving Credit Line, from November 3, 1997 to September 15, 1998, the rates were modified from 34% to 29%, from 29% to 21.70%, and from 21.70% to 20.189%. PNB did not sufficiently explain how it arrived at these increased rates. During trial, PNB’s counsel, Atty. Dennis Somera, admitted that no notices of escalation were sent to Vasquez: “There was no notice of escalation from the bank. It was just a statement of account, your Honor.” PNB itself acknowledged in its Petition that, even without prior notice, it may modify interest rates depending on the future policy it adopts.

A Notice of Sale dated May 24, 1999 was issued by Latorre, Jr., upon an extrajudicial petition for sale under Act No. 3135, as amended, filed by PNB. The public auction of the subject properties was set on June 24, 1999 to satisfy an indebtedness that PNB pegged at P2,363,315.40. On June 21, 1999, three days before the auction, Vasquez filed a Complaint against PNB and Latorre, Jr. before the Regional Trial Court of Imus, Cavite, Branch 20, docketed as Civil Case No. 1927-99, for specific performance, annulment of foreclosure proceedings and damages with prayer for a preliminary injunction. Vasquez alleged that the agreed interest was only 17%, and up to 18% for three years; that he had made partial payments totaling P221,991.36; and that he suspended further payment when PNB unilaterally escalated the interest rate from 17% to 33%, 24%, 34%, 29%, 21.70%, and 20.186% without his prior knowledge and conformity. He claimed that the September 15, 1998 statement of account showed overcharging and excessive interest, including 23% penalties not provided in the Real Estate Mortgage, and that his account had ballooned to P2,071,189.64 as of September 22, 1998 and P2,363,315.40 per the notice of auction sale. He sent two letter-requests for recomputation to delete the excess interest and penalties. He prayed that the interest in excess of 17% be declared illegal and sought P250,000.00 moral damages, P100,000.00 actual damages, and P100,000.00 attorney’s fees. On August 9, 1999, the RTC denied his prayer for a writ of preliminary injunction for being moot and academic because the act to be enjoined was already consummated.

PNB filed its Answer with Counterclaim on July 29, 1999, denying Vasquez’s allegations and praying for dismissal for lack of merit and legal basis. PNB averred that Vasquez had no cause of action because the purported increases in interest rates were freely, voluntarily, and mutually agreed upon by the parties, and that the penalty charges were provided for in the Credit Agreement to which Vasquez agreed and signed. PNB counterclaimed for exemplary, moral, nominal, and temperate damages of P500,000.00 each, P500,000.00 litigation expenses, and P200,000.00 attorney’s fees. Pre-trial was reset several times, mostly for possible settlement, and finally terminated on May 22, 2007. Vasquez testified that he secured a P600,000.00 loan from PNB under the Pangkabuhayan ng Bayan Program, later increased, secured by parcels of land in Tanza, Cavite, and that the initial stipulated interest was 17%. On cross-examination, he said he voluntarily signed the loan agreements and fully understood their terms and conditions, including interest rates and penalty charges in case of default; he recognized PNB’s right to increase or decrease the interest rate but insisted no notice was given before the actual increase. He claimed he tried to tender payment but PNB declined it, and he admitted he did not consign any amount to the court. PNB presented Atty. Ariston Flores and Glenda Agbayani. Atty. Flores testified that Vasquez obtained loans and failed to fully satisfy his obligation, and that the bank imposed penalties and charges as stated in the loan agreements, including a 36% penalty charge in addition to interest upon default. On cross, he clarified that the interest rate under the Pangkabuhayan ng Bayan Program was 16.5% for one year, while an 18% interest rate for 90 days was imposed under the Revolving Credit Line and promissory note. Agbayani, the loan processor when Vasquez obtained the loans, corroborated the rates and denied that the bank unilaterally increased the interest rate.

The RTC found that the Credit Agreement and Promissory Notes were executed by the parties willfully and voluntarily, and that no evidence supported Vasquez’s assertion of partial payments. On appeal, the Court of Appeals found that Vasquez failed to discharge the burden of showing that the obligation had already been discharged, that the record was bereft of any allegation or evidence on the validity of the foreclosure proceedings, and that the evidence established the unilateral imposition of increased interest rates.

• Vasquez — Applicable Interest Rate: Vasquez argued that while the Court of Appeals correctly held that the interest rates imposed by PNB were void because PNB unilaterally imposed increased interest rates, it erred in imposing 12% per annum interest; the rate should be 6% per annum based on applicable jurisprudence.
• Vasquez — Partial Payments: Vasquez alleged that he had already made partial payments on the subject loan obligations amounting to P983,343.38.
• Vasquez — Nullity of Foreclosure: Vasquez maintained that the Court of Appeals erred in not ordering the nullity of the foreclosure of the subject properties.
• PNB — Validity of Interest and Penalty: PNB argued that the Court of Appeals committed serious and reversible error in concluding that the interests applied on the subject loans were void and that the stipulated penalty interest of 36% per annum was unconscionable.
• PNB — Fallback to Stipulated Rates: PNB argued that, assuming the interests and penalties imposed on the subject loans were void, the principal amounts of the subject loans should be subjected to the stipulated rates of interest and penalty.
• PNB — Foreclosure Due to Default: PNB alleged that, having been in default, it acted accordingly when it foreclosed the subject properties.

• PNB as Respondent in G.R. No. 228355 — Defenses in Answer: PNB denied Vasquez’s allegations and maintained that Vasquez had no cause of action because the purported increases in interest rates were freely, voluntarily, and mutually agreed upon by the parties, and that the penalty charges were provided for in the Credit Agreement to which Vasquez agreed and signed.

• Validity of Interest Rate Scheme: Whether the interest rate scheme imposed by PNB under the Credit Agreement and other loan documents is valid.
• Effect on Foreclosure: Whether the nullity of the interest rates invalidates the foreclosure sale of the mortgaged properties.
• Effect on Principal Loan Obligation: Whether Vasquez remains liable for the principal loan obligation and, if so, what monetary and penalty interest rates apply.
• Partial Payments: Whether Vasquez made partial payments sufficient to reduce the principal loan obligation.
• PNB’s Alternative Claim to Stipulated Rates: Whether the stipulated rates of 16.5% and 18% per annum should apply if the interest rates are declared void.
• Default and Foreclosure: Whether Vasquez was in default and whether PNB validly foreclosed the subject properties.

• Validity of Interest Rate Scheme: No. The scheme is null and void for violating the mutuality of contracts under Article 1308; the rates were not fixed and were subject to PNB’s unilateral determination without notice or consent.
• Effect on Foreclosure: The foreclosure sale is null and void. Because the interest rates were void, Vasquez was not in default and PNB had no right to foreclose; registration cannot vest title.
• Effect on Principal Loan Obligation: Vasquez remains liable for P1,375,733.32 after deducting P24,266.68. Monetary interest is 12% per annum from November 8, 1996 to June 30, 2013, and 6% per annum from July 1, 2013 until full payment.
• Partial Payments: No, except for Check Voucher No. RCP-97-012 for P24,266.68 on PN 009/96; the other documents did not refer to the subject loans.
• PNB’s Alternative Claim to Stipulated Rates: No. The loan documents were ambiguous and the original scheme was void; the Court cannot revert to the alleged stipulated rates and instead applies the legal rate at the time of the agreement.
• Default and Foreclosure: No. Vasquez cannot be considered in default for failure to pay illegal interest; default arises only upon failure to pay the obligation upon finality of the Decision.

• Validity of Interest Rate Scheme: The Court examined the Credit Agreement and the promissory notes. Although PNB asserted fixed rates of 16.5% and 18%, the first page of the Credit Agreement for the Pangkabuhayan Loan stated “Prime Rate plus Spread [i]nterest rate”; the Revolving Credit Line proviso was left blank; and the promissory notes referred only to an “applicable” interest rate. No reference rate or formula was provided. Under Spouses Silos vs. Philippine National Bank, an identical “prime rate plus applicable spread” scheme was invalidated as one-sided, indeterminate, and subjective. Under Security Bank Corp. vs. Spouses Mercado, a “prevailing lending rate” is invalid because it depends solely on the bank’s will; a floating rate must be based on a market-based reference rate stated in writing and agreed upon by the parties. Here, no market-based reference rate existed. Even assuming stipulated rates, Section 6.02(b) of the General Conditions allowed PNB to increase the interest rate at any time depending on whatever policy it might adopt in the future; Section 6.02(a) allowed increase or decrease based on PNB’s cost of money; and Section 6.02(c) made PNB’s determination conclusive and binding absent manifest error. The first page of the Credit Agreement, the promissory notes, and the Real Estate Mortgage contained similar unilateral modification clauses. The Statement of Account showed actual varying rates: the Pangkabuhayan Loan rose from 16% to 33%, while the Revolving Credit Line rates changed from 34% to 29%, to 21.70%, and to 20.189%. PNB did not explain how it arrived at these rates, and its counsel admitted that no notices of escalation were sent. PNB itself acknowledged that it may modify interest rates depending on future policy even without prior notice. The escalation was thus solely potestative and not anchored on valid and reasonable standards. Under Article 1308 of the Civil Code, a contract must bind both parties, and its validity or compliance cannot be left to the will of one of them. Escalation clauses are not per se invalid, but they become void when solely potestative. The interest rate scheme was therefore null and void, even assuming Vasquez consented to the provisions.

• Effect on Foreclosure: Because the interest rates were null and void, Vasquez was not in default. Under Article 1252 of the Civil Code, if a debt produces interest, payment of the principal is not deemed made until the interests have been covered. Since the obligation to pay interest was illegal and non-demandable, the principal loan obligation was likewise not yet demandable by PNB. With no default, the foreclosure of the subject properties should not have proceeded. In Heirs of Zoilo Espiritu vs. Sps. Landrito, the foreclosure was invalidated where the debt was overstated due to iniquitous interest; the registration of the foreclosure sale could not vest title. Sps. Albos vs. Sps. Embisan invalidated a foreclosure sale because the interest rates were unconscionable. Sps. Castro vs. Tan nullified foreclosure proceedings where the amount demanded was overstated. Sps. Andal vs. PNB held that since the interest rates were null and void, the bank had no right to foreclose and any foreclosure was illegal; absent default, foreclosure was premature. The foreclosure sale was therefore null and void and could not transfer ownership or possession to PNB. The Court of Appeals erred in finding no evidence to nullify the foreclosure.

• Effect on Principal Loan Obligation: Despite the void interest, Vasquez was not completely relieved. Under Sps. Limso vs. Philippine National Bank, only the interest rate imposed is nullified and deemed not written in the contract; the agreement on payment of the principal loan obligation remains. Vasquez remained obligated to pay the principal of P1,400,000.00 with interest. His claim of partial payments amounting to P983,343.38 was not supported: the cash vouchers and receipts offered did not refer to the subject loans or to PN 009/96PNB and PN 031/96RCL. However, Check Voucher No. RCP-97-012 evidenced payment of P24,266.68 on PN 009/96, the Pangkabuhayan Loan, and bore PNB’s receiving stamp dated February 7, 1997; this amount was deducted from the outstanding principal, leaving P1,375,733.32. As to interest, when a void interest rate is struck down, courts apply the legal rate of interest prevailing at the time the agreement was entered into. The legal rate at the time of the Credit Agreement was 12% per annum. The Court of Appeals did not err in imposing 12% monetary interest. Under Nacar vs. Gallery Frames, the 12% per annum applies from the time the agreement was entered into until June 30, 2013; from July 1, 2013 until finality of the Decision, the monetary interest rate is 6% per annum. Vasquez’s argument for 6% throughout was erroneous because the 6% from default under Nacar refers to compensatory interest, not monetary or conventional interest. PNB’s argument to use the stipulated 16.5% and 18% rates was likewise erroneous because the loan documents were ambiguous and the original interest rate scheme was void; the Court could not refer back to the alleged stipulated rates. As to penalty or compensatory interest, imposing it prior to finality would be inequitable because Vasquez could not be considered in default for failing to pay illegal monetary interest. Under Sps. Andal vs. PNB, a debtor cannot be considered in default for inability to pay arbitrary, illegal, and unconscionable interest rates and penalty charges unilaterally imposed. Vasquez is considered in default only upon failure to pay the obligation upon finality of the Decision. Under Nacar vs. Gallery Frames, legal interest at 6% per annum is imposed on the outstanding principal and monetary interest from finality until full satisfaction.

• Partial Payments: The Court could not give credence to Vasquez’s argument that he had made considerable partial payments warranting significant reduction of the principal loan balance. The documents he offered did not refer to the subject loans; none referred to payments in satisfaction of PN 009/96PNB and PN 031/96RCL. Only Check Voucher No. RCP-97-012, for P24,266.68 with respect to PN 009/96, the Pangkabuhayan Loan, bore PNB’s receiving stamp dated February 7, 1997, and this amount was deducted from the outstanding principal, leaving P1,375,733.32.

• PNB’s Alternative Claim to Stipulated Rates: The Court has held that when an escalation clause is annulled, ordinarily the principal amount should be subjected to the original or stipulated interest rate, as in Equitable PCI Bank vs. Ng Sheung Ngor. That rule did not apply here. The loan documents were ambiguous and unclear as to the real stipulated rate of interest, and the original interest rate scheme itself was null and void for its unilateral nature violating the mutuality of contracts. The Court could not refer back to the allegedly stipulated interest rate scheme and instead resorted to the legal rate of interest at the time of the entering of the loan agreement, which was 12% per annum.

• Default and Foreclosure: Vasquez could not be considered in default for his inability to pay the arbitrary, illegal, and unconscionable interest rates and penalty charges unilaterally imposed by PNB. Since the interest rates were null and void, PNB had no right to foreclose the subject properties, and any foreclosure was illegal. Because there was no default, it was premature for PNB to foreclose the properties subject of the real estate mortgage. Vasquez is considered in default only upon failure to pay the obligation stated upon finality of the Decision. Under Nacar vs. Gallery Frames, when the judgment awarding a sum of money becomes final and executory, legal interest at 6% per annum shall be imposed on the sum from such finality until full satisfaction.

• Mutuality of Contracts — Under Article 1308 of the Civil Code, a contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. The Court applied this principle to strike down PNB’s interest rate scheme because PNB could unilaterally increase or decrease rates based on its own policy, and its determination was conclusive and binding.
• Escalation Clauses — Escalation clauses are not per se invalid; they are valid only if not solely potestative and are based on reasonable and valid grounds. Here, PNB’s escalation was solely potestative and not anchored on valid and reasonable standards, so it was void.
• Floating Interest Rate — Under Section X305.3 of the BSP Manual of Regulations for Banks, a floating rate of interest must be based on Manila Reference Rates, T-Bill Rates, or other market-based reference rates plus a margin agreed upon by the parties; the reference rate must be stated in writing and agreed upon. The loan documents contained no market-based reference rate, so the scheme was not a valid floating rate.
• Effect of Void Interest Stipulation — When an interest rate scheme is void, only the interest rate imposed is nullified and deemed not written in the contract; the agreement on payment of the principal loan obligation remains. The Court applied the legal rate of interest prevailing at the time the agreement was entered into, 12% per annum, then 6% per annum from July 1, 2013 under Nacar vs. Gallery Frames.
• Monetary vs. Compensatory Interest — Monetary or conventional interest is compensation fixed by the parties for the use or forbearance of money; compensatory interest is imposed by law or courts as penalty for damages. The 6% per annum from default under Nacar refers to compensatory interest, while the 12% per annum imposed on the principal is monetary interest.
• Non-default and Invalid Foreclosure — When a loan is burdened with a void interest rate scheme, the debtor is not in default for failing to pay the illegal interest; under Article 1252, if the debt produces interest, payment of the principal is not deemed made until the interests are covered. Since the interest was non-demandable, the principal was not yet demandable, and foreclosure was premature and invalid.
• Torrens System Does Not Vest Title — The registration of an invalid foreclosure sale cannot vest title over the mortgaged property; the Torrens system only confirms and records title already existing and vested and does not permit enrichment at another’s expense.

• 'The principle of mutuality of contracts is pronounced in Article 1308 of the Civil Code, which states that a contract "must bind both contracting parties; its validity or compliance cannot be left to the will of one of them." The principle of mutuality of contracts dictates that a contract must be rendered void when the execution of its terms is skewed in favor of one party.' — This passage states the ratio for invalidating PNB’s unilateral interest rate scheme under Article 1308.
• "Jurisprudence holds that provisions in a loan agreement 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 reek of unilateral authority that is anathema to the mutuality of contracts and enable lenders to take undue advantage of borrowers." — This passage synthesizes the controlling rule applied to PNB’s escalation clauses.
• "Hence, based on established jurisprudence, the fact that the interest rate scheme imposed upon Vasquez was null and void inevitably leads to the invalidity of the foreclosure sale. It would be unjust if the foreclosure sale of the subject properties was considered valid, as this would result in an inequitable situation wherein Vasquez would have his properties foreclosed for failure to pay a loan that was unduly inflated due to the unilateral and one-sided imposition of monetary interest." — This passage links the void interest scheme to the nullification of the foreclosure sale.
• 'The Court has held that in a situation wherein the interest rate scheme imposed by the bank was struck down because the bank was allowed under the loan agreement to unilaterally determine and increase the imposable interest rate, thus being null and void, "only the interest rate imposed is nullified; hence, it is deemed not written in the contract. The agreement on payment of interest on the principal loan obligation remains."' — This passage states the limited effect of the void interest stipulation: the principal obligation survives.

• Spouses Silos vs. Philippine National Bank, 738 Phil. 156 (2014) — Controlling precedent; the Court invalidated PNB’s “prime rate plus applicable spread” scheme as one-sided, indeterminate, and subjective, and followed it here.
• Security Bank Corp. vs. Spouses Mercado, G.R. Nos. 192934 & 197010, June 27, 2018 — Followed; distinguished a valid floating rate based on a market-based reference rate from an invalid “prevailing lending rate” dependent solely on the bank’s will.
• Sps. Limso vs. Philippine National Bank, 779 Phil. 287 (2016) — Followed; nullified PNB’s interest rates for violating mutuality of contracts and held that only the interest rate is nullified while the principal obligation remains.
• Heirs of Zoilo Espiritu vs. Sps. Landrito, 549 Phil. 180 (2007) — Followed; foreclosure proceedings were invalid where the debt was overstated due to iniquitous interest, and registration of the foreclosure sale could not vest title.
• Sps. Andal vs. PNB, 722 Phil. 273 (2013) — Followed; a debtor cannot be considered in default for inability to pay arbitrary, illegal, and unconscionable interest rates and penalty charges, making foreclosure premature.
• Nacar vs. Gallery Frames, 716 Phil. 267 (2013) — Applied; fixed the monetary interest at 12% per annum until June 30, 2013 and 6% per annum thereafter, and imposed 6% legal interest upon finality until full satisfaction.
• Equitable PCI Bank vs. Ng Sheung Ngor, 565 Phil. 520 (2007) — Distinguished; the rule that the original stipulated rate applies after annulment of an escalation clause did not apply because the loan documents were ambiguous and the original scheme was void.
• Sps. Albos vs. Sps. Embisan, 748 Phil. 907 (2014) — Followed; extrajudicial foreclosure sale was invalidated because the interest rates imposed were unconscionable.
• Sps. Castro vs. Tan, 620 Phil. 239 (2009) — Followed; foreclosure proceedings were nullified because the amount demanded as the outstanding loan was overstated due to void interest rates.
• Hun Hyung Park vs. Eung Won Choi, G.R. No. 220826, March 27, 2019 — Cited; distinguished monetary or conventional interest from compensatory interest.

• Article 1308, Civil Code — A contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. Applied to void PNB’s unilateral interest rate scheme.
• Article 1252, Civil Code — If a debt produces interest, payment of the principal shall not be deemed made until the interests have been covered. Applied to hold that because the interest was illegal and non-demandable, the principal was not yet demandable and Vasquez was not in default.
• Article 1169, Civil Code — Cited in relation to default and the 6% per annum compensatory interest under Nacar vs. Gallery Frames.
• Section 6.02(a), (b), and (c), General Conditions (For Individual Borrower), Credit Agreement — These provisions allowed PNB to increase or decrease interest rates based on its cost of money, to increase rates at any time depending on future policy, and made its determination conclusive and binding absent manifest error. They were the core of the unilateral scheme declared void.
• Section X305.3, Manual of Regulations for Banks (BSP) — Floating rates of interest must be based on Manila Reference Rates, T-Bill Rates, or other market-based reference rates plus a margin agreed upon by the parties. The loan documents contained no such reference rate, so the scheme was not a valid floating rate.
• Act No. 3135, as amended — Governed the extrajudicial foreclosure initiated by PNB. Because the interest rates were void and Vasquez was not in default, the foreclosure sale was declared null and void.
• Rule 45, Rules of Court — The consolidated petitions were filed as Petitions for Review on Certiorari under Rule 45.

Carpio (Chairperson), J. Reyes, Jr., Lazaro-Javier, and Zalameda, JJ., concurred. No separate concurring opinions are recounted in the text.