SECTION 5: COMPENSATION

Coverage: Article 1278 – 1290

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

Kinds of compensation:
1. By its extent:
1a. Total Compensation – when the amount of both obligations is the same
1b. Partial Compensation – when the amount of the two obligations is not the
same/different amounts
2. By its cause:
2a. Legal – takes effect automatically if all requisites of law are present; does not need
consent of both parties.
2b. Voluntary – consent is needed because parties need to agree on terms; does not
need to follow all requisites required by law, agreement of parties
is enough
2c. Judicial – court decides compensation
2d. Facultative – only one party has the power to set up compensation

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.

Refers to Legal Compensation – takes effect regardless of will of both parties. Extinguishes debt
to concurrent amount. [Art. 1290]

Requisites to a legal compensation:

1. Both are mutually and principally debtors and creditors of each other
2. The object of obligation is monetary, or of the same kind and quality if the latter is indicated
3. Both of the debts to each other must be due
4. The amount of the debts is clearly fixed
5. No third person hinders the performance of their obligation (e.g., garnishment); they are free
to perform their obligation to one another

Art. 1280. Notwithstanding the provisions of the preceding article, the guarantor may set
up compensation as regards what the creditor may owe the principal debtor.
Example: A owes B P4,000 with C as a guarantor; B owes A P1,000. At due date, A was
insolvent so B sues C. C will only have to pay B P3,000 by virtue of Art. 1280. [The debt of B to
A was offset to the value B can sue C the guarantor (subsidiary liable)].

Art 1281. Compensation may be total or partial. When the two debts are of the same
amount, there is a total compensation.

See Art. 1278 Kinds of compensation by its extent.

Example: A owes B P100; B owes A P100 – total compensation
A owes B P100; B owes A P80 – partial compensation

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

Refers to Conventional or Voluntary Compensation – where both parties can stipulate terms and
does not need to follow all the requisites to a legal compensation.

Requisites to a Voluntary Compensation:

1. Each party has the right to dispose of the credit for which he is seeking reimbursement.
2. They agree to have their credits mutually extinguished.

Even if the debts are not yet due, compensation may still occur if both parties agree to it.

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.

Refers to Judicial Compensation – court is the one who decides the compensation; court may
mitigate damages charged to debtor.

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.

Until they are judicially withdrawn or voided, rescindable and voidable agreements are valid.
Debts may be reimbursed against each other prior to rescission or annulment of the agreement.

Example: A owes B P500. Subsequently, A threatened B to sign a contract of B owing A the

same amount.
The debt of A is valid while that of B is not. Before any judicial declaration, they can both be
compensated against each other.

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.

Concerns the assignment of debt (assigning a new creditor):

Situation
1. Debtor gives consent and
reserves right to compensation
2. Debtor gives consent but does not
reserve right to compensation
3. Debtor does not give consent
Effects
Debtor can compensate/offset all debts due of the other
party to his obligation
Debtor cannot compensate/offset any debts
Can compensate/offset debts prior to assignment

4. Debtor has no knowledge of Can compensate/offset debts prior to gaining knowledge

assignment of assignment

Example: A owes B P10,000. B owes A the following: January 1 – P1,000; January 5 – P6,000.
On January 3 B assigned C as the new creditor. A gained knowledge of assignment on January
6. On January 10 C demands payment from A.

Situation 1: Debtor gives consent and reserves right to compensation.

C can only collect P3,000 since A can compensate all the debts due to his obligation.

Situation 2: Debtor gives consent but does not reserve right to compensation.
C can collect all P10,000 from A since A cannot compensate any of the debts owed to him.

Situation 3: Debtor does not give consent.

C can collect P9,000 since A can only compensate those debts prior to assignment.

Situation 4: Debt has no knowledge of the assignment.

C can only collect P3,000 since A only gained knowledge on January 6, therefore any debts
prior to that can be used as compensation.

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.

In cases where there is a difference in expenses for the fulfillment of the obligation, the party at
loss shall be indemnified if the other party claims compensation.

Example: A obliged himself to deliver 10 cellphones to B who is in America. B also obliged

himself to deliver 10 cellphones of the same quality to A who lives in the Philippines. Cost of
deliver from America to the Philippines is P5,000; Cost to deliver from Philippines to America is
P3,000.
If A claims compensation, he must pay B P2,000 for the excess in expenses of transportation
cost.
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.
Refers to Facultative Compensation – where only one party has the power to compel the other.
Some compensations are not proper such as in a:
1. Depositum
2. Commodatum
3. Support
4. Civil liability arising from crime
Depositum – a type contract in which the depositor entrusts something to the depository for
safekeeping. The keeper must return the deposited property at the same quality when it was
deposited. The Depositor is the one with the power, in this case he can compel the recipient to
offset the thing he has deposited to his obligation to the recipient if he is a debtor thereof.
Commodatum – in short is a contract of borrowing and returning. The borrower cannot offset the
thing he has borrowed to what the lender may have owed him unless the lender is the one who
proposes it. The lender has the power here for any decision with regards to the thing in
question.
Support – such as in arrangements where an ex-husband is obliged to give support to his
children which his ex-wife now takes care of. If ever his ex-wife incurs a debt to him, he cannot
compel the other to offset the amount of debt owed to him and his obligation to support.
Contrary, his ex-wife has the power to demand him to offset the debt she has to him with the
support the ex-husband gives.
Criminal cases – the criminal is not exempted from penalty nor indemnity of the offended party.
The only person who cannot set up the restitution is the criminal. The party who has been
wronged and is entitled to indemnification may file a claim for payment of his debt. (In short, the
offended party can extinguish any obligation he has to the criminal as payment for the criminal,
and still have indemnity for damages.)
Art. 1289. If a person should have against him several debts which are susceptible of
compensation, the rules on the application of payments shall apply to the order of the
compensation.
If there are multiple debts to be paid the most burdensome for the debtor shall be the priority
unless otherwise indicated.
Example: A is indebted to B of the following: (1) P500 with no interest; (2) P500 with 12%
interest; (3) P500 with 30% interest. B owes A P500.
In case A did not ask B of which debt should be paid. A shall pay the one with 30% interest
since it is the most exacting to him.
Art. 1290. When all the requisites mentioned in Article 1279 are present, compensation
takes effect by operation of law, and extinguishes both debts to the concurrent amount,
even though the creditors and debtors are not aware of the compensation.
If all requisites for legal compensation is present it activates automatically regardless of the will
or consent of the interested parties.
Example: A owes B P5,000 due today. B also owes A P4,000 due today. By virtue of Art. 1279,
or legal compensation. The amount A was supposed to pay B, P5,000, is compensated by the
debt of B to A, P4,000, which will result to A paying B only P1,000. (In short the obligation of A
to B automatically reduces to P1,000)