Compensation define in Article 1278

Art. 1278. Compensation shall take place when two persons, in their own right, are creditors and
debtors of each other

Under Art 1278, do not confuse it with confusion or merger. Take note in confusion or merger, the
personalities/characteristics of the creditor and debtor merge in one person. In compensation it is
different, both of them (creditor and debtor) are the mutual creditors and debtors of one another.

So, what does that mean?

 A borrowed from B the amount of 10k

 B in return also borrowed 10k from A.

(Ayaw ingna n mg singlanay ni sla). B is the debtor of A; A is the debtor of B, of the same amount, the same
thing, the same monetary obligation. In that way there is legal compensation, they set off, off set, or
cancel each other’s debt. Why?

- A: Because both of them are mutual debtors and creditors of one another.

Q: What is the distinction of Compensation and Confusion.

Confusion: The personalities of the debtor and creditor merge into one person. (Meaning, in one person
he is the debtor/creditor.

Compensation: There are both parties that remain to exist, the debtor and creditor. Except that they are
mutual debtors and creditors of one another. In that case, it shall set off, off set or cancel the obligation
from each other. (do not confuse the two)

Art. 1279. In order that compensation may be proper, it is necessary: (1) That each one of the obligors
be bound principally, and that he be at the same time a principal creditor of the other; (2) That both
debts consist in a sum of money, or if the things due are consumable, they be of the same kind, and
also of the same quality if the latter has been stated; (3) That the two debts be due; (4) That they be
liquidated and demandable; (5) That over neither of them there be any retention or controversy,
commenced by third persons and communicated in due time to the debtor

Take note there are six (6) requirements under Art 1279 in order that we may say there will be legal
compensation.

Art 1279 talks about legal compensation because the law sets up requirements in order that by law
there will be off setting or in compensation in evidence. So, what are the requirements in order that
legally speaking there can be compensation.

1) Each one of the obligor should be principally bound to the other and they are at the same
time the principal creditor of the other. Take note, mutual creditors and debtors of one
another. Both debts must consist in a sum of money (the first thing you should remember). This
is applicable in cases of monetary obligation.
 2) But, in the case of real obligation (meaning, involving things), they should both involve things
that are: Both things due should be consumable. (Meaning, they are capable of being
consumed/being used by the other. Why? Because if the other can use that object, the other
one can also use it. So, if both are bound for same object that is consumable, both of them can
mutually consume it so they can cancel each other out. In the case of money, for example, that
is a consumable thing, they should be of the same kind and of same quantity, and the latter has
its effects. So this talks about the subject matter of obligation. What can be compensated, what
may be set off or off set.
3) Both debts or both obligation must be due. Take note, they must be due and demandable.
So what if, here:
 A owe B 10k on Feb 1, 2018.
 In return, B owe A the amount of 10k on March 1, 2018.
 Suppose, it is Feb. 14, 2018

A borrowed from B the amount of 10k. Q: On Feb 14, 2018, can A interpose compensation? (Can A say,
“dili nako mubayad ky naa pa mn ka utang sa akoa na 10k)

A: No, because on Feb 14 2018 the debt which B owes in favor of A is not yet due and
demandable. It’s only due and demandable on March 1, 2018.

Q: Suppose it is March 2, 2018, can A interpose the effects of compensation?

A: Yes, because this time the debt of B owed to A is already due and demandable.

Take note of the obligations. If the tenor of the obligation is subject to different conditions, subject to
different period, take note of those terms and conditions; take note of those conditions either
suspensive or resolutory and take note of that period because you know, subjects to different conditions
and terms it has different effects whether or not that obligation is already due and demandable.

For purposes of compensation, it is required that both debts or both obligation must be due and
demandable.

4) Must be liquidated and demandable. (The same thing noh? You must already determine how
much is the extent of your obligation under the contract or your agreement with the other party).
5) Tenor of debt. Over tenor of debt, there be any retention or controversy commence by third
person (that means for example, the things which are subject of the obligation, no other person can
claim adversely against, otherwise, something to say that both obligation should be due and
demandable.

Example:

 10k
 A and B were mutual creditors of each other
 A borrowed B the amount of 10K
 It turned B creditor also has other creditors. (Meaning utangan c B sa laing tao). Let us say that it
is X.
 B borrowed A the amount of 10k. So there can be compensation.
 What if, Before the debt is incurred by B, what if X try exercise Art 1177. X who is the debtor of B
might to pursue the real property in favor of B.

What are some of the properties that X wanted to pursue in order to exercise his right under Art
1177?

Let us say that X wanted to pursue the 10K or wanted to garnish it.

Example, X filed an action to RTC saying that “B utangan sa ako”. X wanted to attached the credit - the
debt that A owes B. Imbis na si A mubayad kay B, A will now be paying against X.

What if subsequently si B ngkautang as against A also to the amount of 10k. Q: As to between the two
debts, can be there legal compensation under Art 1279?

A: No. Both debts are not yet liquidated. They are subject to a retention, specifically the one -the subject
of controversy that a third person is claiming as against B (the principal debtor/creditor in the situation).
Therefore, there could be no any legal compensation.

6) There must be communication in due time to the debtor (the principal debtor), the party
incurred the debt first.
In the case it is A because it is to A’s benefit that compensation take place.

What are prohibited forms of compensation? Take note, both debts must be of the same time or
must be identical (meaning, they must pertain to the same thing which is a sum of money, or the
thing due which is consumable), they must be of the same kind or same quality under the second
requisite.

So, what are FORMS OF PROHIBITED COMPENSATION OR OFF-SETTING?

1) Debts arising from a contract of deposit except in the case of bank deposit.

Take note: The contract or the agreement between a borrower of a bank and the bank itself, we call
it deposit. (that is why, diba, sweldo, or you get your pay, people who want to deposit their cash to
the bank they would say “I have to DEPOSIT first”. There is legally what do we call a CONTRACT TO
DEPOSIT.

Q: Example, bank-BPI. Between A and BPI, if A will deposit his sweldo the amount of 50K, does that
refers to a contract to deposit?

A: No. Remember that the contract between the borrower or any as new clients of banks and
the banks, technically there is a debtor/creditor relationship. Why?

 When we try to analyze it, if you put money to the bank, the bank will issue you for example an
ATM. Dba? The bank actually borrowed you money that is why they will pay you interest.
Because you lend your money to the bank, the bank is actually the debtor and you (client of the
bank) is the creditor.
So in this transaction, in a bank deposit, take note the relationship of the parties is a
debtor/creditor relationship.
 Illustration:

 What if You deposited to BPI the amount of 50K your salary.

Who is the debtor?
- Let us say the BPI

Who is the creditor?

- Let us say, YOU.

 What if YOU also have a transaction with BPI? What if you have a loan, you borrowed money
from BPI also. The installment or the amortization of the loan that is due this month is the
amount of 50K.

Let us just assume that there is no interest. In short you deposited with BPI the amount of 50k BPI
borrowed from YOU. But, since YOU took out a loan, you also is a borrower of BPI. BPI issued you a
loan so that you can borrow money. That part of the loan that is due and demandable is to the
amount of 50K.

Now, can YOU say that instead of BPI deposit you the amount of 50K, they will now have off-
setting. In your payroll of 50K instead of going to your savings account, to your payroll acct
whatever., it will be in payment of your debt. Q: Is that allowed?

A: Yes. Legal Compensation. Because as between clients of banks with their bank there
is a debtor/creditor relationship.

So, since both debts are of the same kind and quality that is due and demandable, it can be
subject to legal compensation.

Q: What is a situation where a bank after a bank or in a relationship with a bank, you cannot
have an off-setting with compensation. In banks there are what do we call safety deposit boxes.
(Sa mga mayayaman jan o sa my mga title ng mga lupa, instead of keeping those jewelries, or
titles of properties with you. Hadluka ana kawaton? So what you could do, ask the bank to set
up a savings deposit box.). It is a literal box that you rent out.

Q: What is the relationship bet you and the bank, is it a debtor/creditor relationship?

A: No. In this case, this is what do we call a contract of deposit or depositum , so this is a
legal contract of deposit. (Not literally n mg deposit sa ko sa bank). In this case, the depositor is
you, the one who made the deposit. The bank who keeps the thing that you deposit, we call
them the depositary.

 What if again, same example, YOU borrowed money from the bank the amount of 100K. Let’s
say the jewelry amounts to 100K. Can you say that there will be an off-setting? Instead of paying
the value of your rental, the jewelry that you put, what you want is apply the jewelry to the
amount or the portion that is due and demandable on your loan with the bank.
A: NO. They are not of the same kind of debt, they are different obligations – a contract
of deposit and a contract of loan.
Both debts are not of the same kind or quality, they may not be off-set. There cannot be
any compensation.
*Debts arising from a contract of deposit is a prohibited compensation.

In the book of Tolentino. Debts arising from obligations of a bailee in commodatum. In persons and
family relations, debts arising from a claim for future support due by gratuitous title, can there be a
compromise from a future support? Dba hindi.

-You cannot agree in a future on anything with respect to support.

Example,

o A and B are husband and wife,

o B is the husband; A the wife
o The husband owes support
o The wife also owes the husband in the amount of 10k which is a loan
o They are under complete separation.

Q: Can you say that the support owed by the husband to the wife, can that be off set by the obligation of
the wife with respect to the husband? Can there be a legal compensation?

A: No. Because both debts are not of the same kind. The obligation of the husband to the wife is
support, that is a legal obligation under the family code but the obligation of the wife to the husband, is
a civil obligation by virtue of a contract-the contract of loan. So, since they are not of the same kind they
cannot be offset.

*Legal compensation its effect by operation of law, it extinguishes both debts up to the concurring
amount even though the debtors and creditors are not aware of that compensation because legally
speaking, legal compensation happens by operation of law.

What do you call that type of compensation where the parties agree that there will be off setting or the
debts be cancelled out because of compensation? We call this conventional or voluntary compensation
of Art 1282

Art. 1282. The parties may agree upon the compensation of debts which are not yet due

Take note, that when the parties agree about compensational debts that is what do we call conventional
or voluntary.

Judicial compensation legally is a contract they call it set off. Setting off is another term for judicial
compensation.

Art. 1283. If one of the parties to a suit over an obligation has a claim for damages against the other,
the former may set it off by proving his right to said damages and the amount thereof.

Compensation with respect to an action instituted in court by the parties claiming for damages.
Compensation with respect to an action instituted by the parties incurred for damages.

Q: Can you cancel an action with another action?

A: No. What is cancelled is the claim for damages not the action.
 Ex. Someone files an action against you in court for some of money so they will pay their debt. If
you file an action for a sum of money.

Q: Can you say that “judge dismiss my case because there is legal to compensation?”

A: OFCOURSE NO. That is not legal or judicial compensation. Under 1283, What is offset is not
the actions that are pending in court between the parties. What is offset, is the right or the claim for
damages in their respective action because those are civil liabilities arising from those actions.

Art 1283 is an example of what do we call set off or judicial compensation.

Art. 1284. When one or both debts are rescissible or voidable, they may be compensated against each
other before they are judicially rescinded or avoided.

RESCESSIBLE OBLIGATIONS OR VOIDABLE CONTRACTS OR OBLIGATIONS, THESE ARE OBLIGATIONS THAT

ARE DEFECTIVE FROM THE START BUT THEY HAVE A VALID EFFECT UNTIL THEY ARE RESCINDED OR THEY
HAVE DECLARED NULL AND VOID.

Like in family relation you have nullable marriages, those marriages are valid until they are declared void
(in an annulment case). In the same way, these obligations involve, are in contracts for example, and
those contracts under the law on contracts are rescissible contracts under Art 1382, 83 & 84, or voidable
contracts under law contracts. Compensation may happen to them because they remain to be valid until
they have been declared, rescinded or voided.

Art 1285. EFFECT OF ASSIGNMENT TO A THIRD PERSON WITH RESPECT TO THE COMPENSATION OF
DEBTS

Art. 1285. The debtor who has consented to the assignment of rights made by a creditor in favor of a
third person, cannot set up against the assignee the compensation which would pertain to him against
the assignor, unless the assignor was notified by the debtor at the time he gave his consent, that he
reserved his right to the compensation.

If the creditor communicated the cession to him but the debtor did not consent thereto, the latter
may set up the compensation of debts previous to the cession, but not of subsequent ones.

If the assignment is made without the knowledge of the debtor, he may set up the compensation of
all credits prior to the same and also later ones until he had knowledge of the assignment

Art. 1286. Compensation takes place by operation of law, even though the debts may be payable at
different places, but there shall be an indemnity for expenses of exchange or transportation to the
place of payment

Obligation arises in payment in the proper place where the payment should be made or compensation
was made.
Art 1287 in relation to 1288. FACULTATIVE COMPENSATION.

Facultative compensations. They may be claim or oppose by one of the parties such that by not of the
other requisites of legal compensation arises

What is our rule?

-Under Art 1279 legal compensation, compensation that takes place by operation of law, when all of the
requirements under Art 1279 concur they should be called legal compensation.

Q: Those requirements were not perfect, meaning some requirement are not yet happen, can there be
still legal compensation?

- In a close sense, yes.

What do we call that type of compensation when not all requisite under Art 1279 is present.
We call that facultative compensation. Compensation that may be claim or oppose by
anyone of the parties. (meaning, when a debtor or a creditor claims an imperfect
compensation, that is what do we call facultative. It depends upon the will of anyone of
them.

Art 1287 & Art 1288

Art. 1287. Compensation shall not be proper when one of the debts arises from a depositum or from
the obligations of a depositary or of a bailee in commodatum. Neither can compensation be set up
against a creditor who has a claim for support due by gratuitous title, without prejudice to the
provisions of paragraph 2 of Article 301.

Art. 1288. Neither shall there be compensation if one of the debts consists in civil liability arising from
a penal offense.

These Articles discuss prohibited compensation. (meaning, compensation cannot technically or legally
happen by operation of law because it was not complied with all the requisites of Art 1279. However, if
by the will of anyone of the parties, those parties whether the debtor or creditor they complain to the
delay of compensation imperfectly under these 2 provisions.

What do you call that type of prohibited compensation?

- That is facultative compensation. It is an imperfect compensation or offsetting. What if

anyone claim otherwise by the choice of anyone of the parties (either creditor or debtor,
malamang c debtor pra ma extinguish iyang obligation) this may give rise to such type of
imperfect compensation called facultative compensation.

Art 1289. RULES OF APPLICATION OF PAYMENTS.

Take note, APPLICATION OF PAYMENT is a separate or a special form of payment, it doesn’t mean that
Application of payment is not applicable to compensation.

If a person should have several debts against him which are susceptible of compensation, the
RULES ON APPLICATION OF PAYMENTS SHALL APPLY.
 What are those rules?

1. If they are not of the same type or quality or they are not of the same feature.
Which debt should you prefer?
- You prefer the most onerous debt.
But, if of the same nature or same type
- Apply them proportionately. (meaning, the entire debt will be as to portions or extent of the
remaining debts that are due and demandable)

In the application of payments, instead of choosing assume that problem the debtor is mutual creditor
and debtor of all the separate creditors.

Case: Art 1278 Francia vs. IAC

Facts:
Engracio Francia is the registered owner of a residential lot and a two-story house. On October 15,
1977, a 125 square meter portion of Francia's property was expropriated by the Republic of the
Philippines for the sum of P4,116.00. It appears that Francia did not pay his real estate taxes from
1963-1977 and because of this his property was sold at public auction by the City Treasurer.

On March 20, 1979, Francia filed a complaint to annul the auction sale.

Francia contends that his tax delinquency of P2,400.00 has been extinguished by legal
compensation. He claims that the government owed him P4,116.00 when a portion of his land was
expropriated on October 15, 1977

Held:

Q: What is it that the government owes Francia that when it exercises its power of eminent domain?

- Just compensation.

Accdg to Francia because of just compensation that the government owes me there should be
offset as against the tax that supposedly the govt owned. You take away my property because I
did not pay my tax

Q: Can the liability for tax be offset for the obligation of the govt supposedly for just compensation?

No.There is no legal basis for the contention. By legal compensation, obligations of persons, who
in their own right are reciprocally debtors and creditors of each other, are extinguished (Art.
1278, Civil Code). The circumstances of the case do not satisfy the requirements provided by
Article 1279, to wit:

(1) that each one of the obligors be bound principally and that he be at the same time a principal
creditor of the other;

(2) that the two debts be due.

There can be no off-setting of taxes against the claims that the taxpayer may have against the
government. A person cannot refuse to pay a tax on the ground that the government owes him
 an amount equal to or greater than the tax being collected. The collection of a tax cannot await
the results of a lawsuit against the government.
The tax was due to the city government while the expropriation was affected by the national
government. Hence there could be no legal off setting.

Obviously, the debts are not of the same kind or quality therefore it cannot be offset.

Case Art 1278. MONDRAGON PERSONAL SALES, INC. v. VICTORIANO S. SOLA, JR.,
G.R. No. 174882, January 21, 2013

Mondragon Personal Sales Inc., a company engaged in the business of selling various consumer products
through a network of sales representatives, entered into a Contract of Services 3 with respondent Victoriano
S. Sola, Jr. for a period of three years commencing on October 2, 1994 up to October 1, 1997. Under the
said contract, respondent, as service contractor, would provide service facilities, i.e., bodega cum office, to
petitioner's products, sales force and customers in General Santos City and as such, he was entitled to
commission or service fee.

Prior to the execution of the contract, however, Victoriano’s wife, Lina Sola, had an existing obligation with
Mondragon arising from her Franchise Distributorship Agreement and because of this existing obligation, .
On January 26, 1995, Mr. Sola wrote a letter addressed to Renato G. de Leon, Mondragon's Vice-President
for Finance, wherein he acknowledged and confirmed his wifes indebtedness to petitioner in the amount
of P1,973,154.73 (the other accountability in the sum of P1,490,091.15 was still subject to reconciliation)
and, together with his wife, bound himself to pay on installment basis the said debt.