OBLI STUDY GUIDE: CHAPTER 4, SEC.

5 –Compensation (Articles 1278-1290)

SECTION 5
COMPENSATION
(Arts. 1278-1290)

STUDY GUIDE:

1. What is compensation? (Art. 1278)

 Compensation is the extinguishment to the concurrent amount

of the debts of two persons who, in their own right, are reciprocally
debtors and creditors of each other.

 Illustrative Example: If Debbie owes Charles P100,000.00,

and Charles also owes Debbie P100,000.00, and both debts are due, then
both obligations will be extinguished by compensation (set-off).

2. What are the kinds of compensation as to extent or as to their

effects? (Art. 1281)

(a) TOTAL – when both obligations are of the same amount, and
are entirely extinguished.
 Example: Debbie owes Charles P100,000.00. In another
obligation, Charles likewise owes Debbie P100,000.00. Both debts are
due for payment on 15 April 2020. Here, the parties need not pay each
other as their obligations are completely extinguished by total
compensation. (Art. 1281.) The two debts are extinguished without
actual transfer of money between the parties.

(b) PARTIAL – when the two obligations are of different amounts,

and a balance remains.

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 Example: Darwin purchased on credit school supplies

amounting to P80,000.00 from Criselda, the sole proprietor of Maduruto
Bookstore. Criselda likewise purchased on credit 500 pieces plain white
shirts totaling to P100,000.00 from Darwin, owner of Barato General
Merchandising. Both debts are now due. Here, compensation takes
place partially, that is, to the concurrent amount of P80,000.00. Hence,
Criselda shall be liable to Darwin for only P20,000.00.

3. What are the kinds of compensation as to origin?

(a) LEGAL – when it takes place by operation of law, even without

the knowledge of the parties, such as in the examples
above. (Arts. 1279 & 1290)

(b) VOLUNTARY/CONVENTIONAL – when it takes place by

agreement of the parties. (Art.
1282)
 Voluntary or conventional compensation includes any
compensation which takes place by agreement of the parties even if all
the requisites for legal compensation are not present. This kind of
compensation has no special requisites. It is sufficient that the contract of
the parties, which declares the compensation, is valid. (Art. 1306.)
 Example: Fely owes Greg P100,000.00 due for payment
on 12 April 2020. In another obligation, Greg owes Fely the delivery of a
motor bike worth P100,000.00 due for payment on 30 April 2020. In this
case, legal compensation cannot set in because the debts are of different
kinds and both are not yet due. However, if Fely and Greg agree on 12
April 2020 that both their debts will be extinguished by compensation, then
they will be completely released of their liability to each other by
conventional compensation.

(c) JUDICIAL – when it takes place by order from a court in a

litigated case. (Art. 1283)

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OBLI STUDY GUIDE: CHAPTER 4, SEC. 5 –Compensation (Articles 1278-1290)

 Illustrative Example: If Connie sues Dondon for the

collection of the sum of P300,000.00, Dondon may file a counterclaim that
Connie is likewise liable to her for damages in the amount of, say,
P200,000.00 arising out of another incident or transaction. If during the
trial Connie and Dondon are able to prove their respective claims, the
court in its decision shall order a partial judicial compensation or set-off
and order the obligation of Connie to Dondon in the amount of
P200,000.00 extinguished. Dondon will then be ordered to pay Connie
the difference of the two debts in the amount of P100,000.00.

4. What are the requisites of legal compensation? (Art. 1279)

(a) The parties must be principal creditors and principal debtors of

each other.
(b) Both debts must consist in a sum of money or, if the things due
are consumable, they must be of the same kind, and also of the
same quality, if the latter has been stated.
(c) The two debts must be due and demandable.
(d) The two debts must be liquidated.
(e) There must not be any retention or controversy, over either of the
debts, commenced by third persons, and communicated in due
time to the debtor.
(f) The compensation is not prohibited by law.

 NOTE: The requisites mentioned refer to compensation by

operation of law. Even if there is no agreement voluntarily and validly
entered into, as long as all the above requisites are complied with,
compensation will set in. (Arts. 1279 & 1290)

 Illustrative Examples:

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 Demy owes Ginger P2 million. In another obligation, Caloy

owes Demy P2 million, which debt is guaranteed by Ginger. In this case,
Demy’s obligation to Ginger will not be extinguished by compensation.
This is because while Ginger is the principal creditor of Demy in the first
debt, Demy is not the principal creditor of Ginger in the second debt.
[Art. 1279 (a)]

 If Demy owes Caloy P2 million, and Caloy owes Demy the

delivery of a car valued at P2 million, there can be no compensation. The
two debts do not consist in a sum of money. [Art. 1279 (b)]

 Demy owes Caloy P2 million due on 10 April 2020. On the

other hand, Caloy also owes Demy P2 million due on 15 April 2020. If
Caloy goes to Demy demanding for payment of her obligation on 12 April
2020, there can be no compensation. This is because as of 12 April 2020,
the two debts to be compensated are not yet due. Only the debt of Demy
to Caloy is due. However, if Caloy demands for payment from Demy of
her P2 million debt on 16 April 2020, Demy can now set up compensation,
because then both debts are already due. [Art. 1279 (c)]
 In the obligation in number  above, assume that Caloy
demands from Demy payment of her obligation on 15 April 2020.
However, a writ of garnishment has been issued by the court, upon the
instance of Serena (a creditor of Demy, who had earlier filed a suit against
Demy), ordering Caloy to withhold payment of his obligation to Demy.
There can be no compensation here because the second debt is involved
in a controversy. [Art. 1279 (b)]

5. Can the guarantor set up compensation as regards what the creditor

may owe the principal debtor?
 YES. Compensation benefits the guarantor (Art. 1280)
because the extinguishment of the principal obligation carries with it that of
the accessory obligation of guaranty.

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 Illustrative Example: Dahlia owes Cesar P500,000.00, which

debt is guaranteed by George. In another obligation, Cesar likewise owes
Dahlia P300,000.00, which is an unsecured debt. On maturity date, Cesar
is unable to collect from Dahlia. Cesar, therefore, sues the guarantor
George for Dahlia’s P500,000.00 indebtedness. Under the facts, George
may set up the defense of compensation of the two debts so as to make
him liable to Cesar for only P200,000.00.

6. Concept of Assignment of Credit. – Assignment of credit is a contract

whereby a person (assignor) transfers his credit, right or action
against a third person to another (assignee) for a consideration
certain in money or its equivalent.

A. Where Compensation Takes Place Before Assignment of

Credit Rights. – When compensation takes effect by operation of law or
automatically, the debts are extinguished to the concurrent amount. If
subsequently, the extinguished debt is assigned by the creditor to a third
person, the assignment is not effective since the obligation has already
been automatically extinguished by legal compensation. There is nothing
more to assign.

 Illustrative Example: Dean owes Cristine P500,000.00 payable

on 10 April 2020. In another obligation, Cristine also owes Dean
P500,000.00 due for payment on 5 April 2020. On 15 April 2020, Cristine
assigns her right to collect P500,000.00 from Dean to Shiela. Under the
facts, Cristine’s assignment of her P500,000.00 credit to Shiela is NOT
effective if all the requirements for compensation are present on 10 April
2020 because as of said date, the obligation to Dean has already been
extinguished by compensation. EXCEPTION: The only exception is if
the debtor Dean consented to the assignment of the credit to Shiela. In
this case, the assignment of the credit to Shiela becomes effective.
Therefore, the liability of Dean remains effective, and Shiela can collect
from Dean. Hence, if Shiela goes to Dean on 20 April 2020 collecting
under this obligation, Dean must pay Shiela the amount of P500,000.00.

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Later on, Dean can just collect from Cristine his P500,000.00 credit if
payment has not as yet been made.

B. Where Compensation Takes Place After Assignment of

Credit Rights. – Article 1285 speaks of the following cases of
compensation which take place AFTER an assignment of credit rights
made by the creditor, to wit:

 The assignment was made with the consent of the debtor where
the debtor DID NOT RESERVE his right to the compensation. – In this
case, the debtor cannot set up compensation as he is deemed to have
waived his right thereto when he gave his consent.

 Illustrative Example: Dan owes Chie P500,000.00 due on 20

April 2020. In another obligation, Chie owes Dan P300,000.00 due on 15
April 2020. On 18 April 2020, Chie assigned her credit to Annie with
Dan’s consent. If Annie will collect her credit on 20 April 2020, Dan
cannot set up against Annie the compensation that he can set up against
Chie because he has waived his right thereto. In this case, Dan will have
to pay Annie P500,000.00, and later on collect Chie’s P300,000.00 debt.

 The assignment was made with the consent of the debtor where
the debtor RESERVED his right to the compensation. – In this case, the
debtor can set up compensation against the assignee.

 Illustrative Example: Dan owes Chie P500,000.00 due on 20

April 2020. In another obligation, Chie owes Dan P300,000.00 due on 15
April 2020. On 18 April 2020, Chie assigns her credit right to Annie with
Dan’s consent, but with Dan reserving his right to set up compensation
against the assignee. In this case, if Annie collects the credit on 20 April
2020, Dan can set up compensation against her up to P300,000.00,
representing the amount that Chie owes him. Hence, Dan will be obliged
to pay Annie only the balance of the credit in the amount of P200,000.00.

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 The assignment was communicated to the debtor but the debtor

DID NOT CONSENT to it. – In this case, the debtor can set up
compensation with respect to the debts maturing BEFORE the
assignment, but not for debts due AFTER notice of the assignment was
given to the debtor.

NOTE: The debtor’s consent is not required for the validity of the
assignment. However, actual notice must be given to him of
the assignment so that he could make his payment to the
creditor-assignee.

 Illustrative Example: Dan owes Chie P500,000.00 due on

15 April 2020. On the other hand, Chie owes Dan the following debts:

P150,000.00 due on 1 April 2020;

P 80,000.00 due on 8 April 2020; and
P 70,000.00 due on 14 April 2020.

On 12 April 2020, Chie assigned his credit to Annie with notice to Dan, but
Dan did not give his consent to the assignment. If Annie collects the
credit from Dan on 15 April 2020, Dan can set up compensation with
respect to the debts due on 1 April 2020 ( 150,000.00) and 8 April 2020
(80,000.00), which had already matured at the time of the assignment
on 12 April 2020. Thus, Dan can be held liable to Annie for only
P270,000.00 (P500,000.00 – P150,000.00 – P80,000.00).
Annie can then collect the balance of P230,000.00 from Chie.

 The assignment was made WITHOUT THE KNOWLEDGE of

the debtor. – In this case, the debtor can set up compensation with
respect to the debts maturing before he obtained knowledge of the
assignment.

 Illustrative Example: Dennis owes Claire P400,000.00 due

on 25 March 2020. On the other hand, Claire owes Dennis the following
debts:

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P160,000.00 due on 1 March 2020;

P 60,000.00 due on 8 March 2020;
P100,000.00 due on 14 March 2020; and
P 40,000.00 due on 31 March 2020.

On 12 March 2020, Claire assigned her credit right to Abner without the
knowledge of Dennis. On 16 March 2020, Dennis learned of the
assignment. In this case, Abner will be able to collect from Dennis only
the amount of P80,000.00 because Dennis may set up compensation
with respect to the debts due on 1 March 2020 ( 160,000.00), 8 March
2020 (60,000.00), and 14 March 2020 (100,000.00), which debts have
become due as of 16 March 2020 when Dennis came to know of the
assignment. Abner can also collect the remaining balance of his credit in
the amount of P40,000.00 from Claire.

7. What are the cases provided under the Code when legal
compensation is prohibited?

(a) If only one party has the right to claim or oppose the
compensation. This is known as facultative compensation.

 Illustrative Example: Ding owes Chari P500,000.00

payable on or before 31 March 2020. Chari likewise owes Ding
P500,000.00 payable on 1 March 2020. Since the period in the first
obligation is for the benefit of Ding (the debtor is said obligation), he may
pay on or before 31 March 2020. So Ding can claim compensation on 1
March 2020. If Chari claims compensation on 1 March 2020, Ding may
oppose it since he cannot be compelled by the creditor to make payment
before 31 March 2020.

(b) If one of the debts arises from a depositum, or from the

obligations of a depositary (Art. 1287, par. 1). This is also a case
of facultative compensation.

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OBLI STUDY GUIDE: CHAPTER 4, SEC. 5 –Compensation (Articles 1278-1290)

 Contract of Deposit as Distinguished from a Bank Deposit. –

A deposit is a contract whereby a person receives a thing belonging to
another with the obligation of safely keeping it and of returning the same.
(Article 1962, NCC) The depositor may claim or oppose any
compensation, but not the depositary. The depositary is not allowed to
claim compensation to prevent breach of trust and confidence since a
contract of deposit is fiduciary in character. A contract of deposit does not
include within its purview a bank deposit, which is actually a contract of
loan. (Article 1980, NCC) In the case of a bank deposit, legal
compensation is allowed.

 Illustrative Example (Deposit): Daisy deposited 500 sacks of

rice with Clyde. Later, Daisy borrowed 500 sacks of rice from Clyde
payable on 5 April 2020. If on 5 April 2020, Daisy demands the return of
the 500 sacks of rice she deposited with Clyde, Clyde is required to return
them to Daisy. Clyde (the depositary) cannot claim compensation on the
ground that Daisy (the depositor) also owes him 500 sacks of rice. This is
so because the obligation of Clyde to return the 500 sacks of rice to Daisy
arises from a contract of deposit. However, if Clyde demands the delivery
of the 500 sacks of rice that Daisy owes him, Daisy (the depositor) is
allowed to claim compensation with respect to the 500 sacks of rice she
deposited with Clyde (as depositor), thereby extinguishing her obligation
(as debtor) under the contract of loan with Clyde (the creditor).

 Illustrative Example (Bank Deposit): Dinky deposited P5

million with Matipid Bank and Trust Company (MBTC). But Dinky has a
loan obligation to MBTC in the amount of P2 million which is already due.
Without asking the permission of Dinky, MBTC deducted P2 million from
his account.
Question: Is MBTC allowed to claim compensation?
Answer: YES. The bank may claim compensation because the
relationship between a bank and its depositor is that of a debtor and
creditor.

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(c) If one of the debts arises from the obligations of a bailee in

commodatum (Art. 1287, par. 1). This is also a case of facultative
compensation.

 Contract of Commodatum Defined. – Commodatum is a

contract whereby a party delivers to another a non-consummable thing so
that the latter may use the same for a certain time and return it. (Article
1933, NCC) The bailor or lender may claim or oppose any compensation,
but not the bailee or borrower. The bailee or borrower is not allowed to
claim compensation so that he will not breach the trust and confidence
reposed upon him by the bailor or lender.

 Illustrative Example: Dante obliged himself to give

Charmaine a 2019 750i BMW car. Later, Charmaine (the bailee)
borrowed from Dante (the bailor) his 2017 750i BMW car. If Dante
demands the return of the car that Charmaine borrowed, she is required to
return it. Charmaine cannot claim compensation on the ground that Dante
owes her a 2019 750i BMW car because Dante’s obligation to return
arises from commodatum. However, if Charmaine demands the delivery
of a 2019 750i BMW car that Dante owes him, Dante may claim
compensation.

(d) If one of the debts arises from a claim for support due by
gratuitous title [except support in arrears, or past support, which
may be compensated with the debt of the person entitled to
support] (Art. 1287, par. 2; Review also Article 194 of the Family
Code, on what comprises support, and Article 195 of the Family
Code, on the persons obliged to support each other).

 Who may claim compensation. – The party entitled to receive

support may claim or oppose any compensation, but not the party
required to give support. This is so because support is essential to the life
of the person being supported, and he will be deprived of his right to live if
the party required to give support can claim compensation. However,
support in arrears may be compensated because even if such support

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was not given, the party entitled to receive support has managed to
survive. (See Art. 301, NCC.)

 Illustrative Example:

 Sweetie and Honey are husband and wife. In a complaint

for legal separation filed by Honey against Sweetie, Sweetie was ordered
by the court to give a monthly support of P50,000.00 to Honey payable
on the first day of each month. On 1 April 2020, Honey demanded her
support for April, but Sweetie refused claiming that Honey owes him
P50,000.00, which is already due.

Question: Is Sweetie allowed to claim compensation?

Answer: NO. The party required to give support cannot claim

compensation. However, if Sweetie demands the payment of the
P50,000.00 that Honey owes him, Honey may claim compensation, at
her option.

 Assume that in the preceding example, Sweetie has not

yet given the support of Honey for March, 2020, the past month.

Question: If Honey demands the payment to her of such support,

may Sweetie claim compensation on the ground that Honey still owes him
P50,000.00 which is already due?

Answer: YES. Both parties may claim compensation if the

support due is support in arrears ( i.e., past support which has not been
paid yet), but NOT future support which is still to be claimed.

(e) If one of the debts consists in civil liability of the offender arising
from a penal offense (Art. 1288). This is also a case of facultative
compensation.

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OBLI STUDY GUIDE: CHAPTER 4, SEC. 5 –Compensation (Articles 1278-1290)

 Who may claim compensation. – Under Article 1288, the

offender is not allowed to claim compensation because the satisfaction of
the obligation is imperative. The offended party, however, may claim
compensation or oppose any compensation being claimed by the
offender.

 Illustrative Example: Diego stole five horses owned by

Consuelo. He was arrested, tried and convicted of theft, and was ordered
by the court to pay P300,000.00, representing the value of the stolen
horses. Consuelo, however, owes Diego P300,000.00 by way of loan
which is already due. If Consuelo demands the payment to her of the
P300,000.00 representing the value of the horses, Diego cannot claim
compensation. However, if Diego demands the payment of the loan of
P300,000.00 from Consuelo, the latter, at her option, may claim
compensation.

8. Article 1289.  Rules on Application of Payment. – If a person

should have against him several debts which are susceptible of
compensation, the rules on application of payments from Articles
1252 to 1254 shall apply to the order of the compensation.

 Illustrative Example: Daniel owes Chona the following debts:

P30,000.00 due on 10 March; P30,000.00 due on 15 March;
P30,000.00 due on 20 March; and P30,000.00 due on 30 March.
Chona, on the other hand, owes Daniel P30,000.00 due on 22 March.
On 22 March, Daniel must inform Chona which of his debts due on 10, 15
and 20 March (which have become due as of 22 March) shall be the
object of compensation. If Daniel does not designate the debt to which
compensation shall apply, the right is shifted to Chona to designate which
of such debts that have become due shall be the object of compensation.
If Chona also fails to avail herself of such right, compensation shall be
applied proportionately to the three debts already due at P10,000.00
each.

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OBLI STUDY GUIDE: CHAPTER 4, SEC. 5 –Compensation (Articles 1278-1290)

 READ THESE CASES IN THEIR ORIGINAL TEXT:

(1) Nadela vs. ECCO-Asia, G.R. No. 145259, 25 October 2005.

(2) Mavest (U.S.A.) vs. Sampaguita Garment Corporation,

G.R. No. 127454, 21 September 2005.

(3) PNB vs. CA, G.R. No. 108052, 24 July 1996.

*** END ***

HAPPY READING & LEARNING!

FOOD FOR THOUGHT

It was character that got us out of bed, commitment that
moved us into action, and discipline that enabled us to
follow through.
Zig Ziglar

Winners embrace hard work. They love the discipline of it,

the trade-off they’re making to win. Losers, on the other
hand, see it as punishment. And that’s the difference.
Lou Holtz

I believed in studying just because I knew education was a

privilege. It was the discipline of study, to get into the habit
of doing something that you don’t want to do.
Wynton Marsalis

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