Law Contracts Guide CPA Review

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LAW ON CONTRACTS
ATTY. NICKO SORIANO, CPA
LAW ON CONTRACTS
TOPIC OUTLINE:
1. General Provisions
a. Definition
b. Classification
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c. Stages of contract
d. Freedom to contract (establish stipulations) and limitation
e. Persons bound
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2. Essential requisites
a. Consent
i. Requisites
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ii. Capacitated Persons
iii. Vices of consent
b. Objects of contract
c. Cause of considerations of contracts
3. Forms of Contracts
4. Reformation of instruments/contracts
5. Interpretation of contracts
6. Defective contracts
a. Resistible
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b. Voidable
c. Unenforceable
d. Void and inexistent
CONTRACTS IN GENERAL
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DEFINITION – A contract is a meeting of minds between two persons whereby one binds himself, with respect to the other,
to give something or to render some service. (Art. 1305)
Criticisms in the definition provided under Art. 1305:

1. “to give something or to render some service” – connotes that obligation not to do is not covered, which is wrong. E.g.,
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contract not to put up a fence or not to sell products of a competitor company, or in the case of Honda cars prohibiting
conversion of the cars to taxicabs.
2. “whereby one binds himself” – connotes that only one is obligated, which is wrong as well. Most of the contracts are
actually reciprocal or bilateral.
3. “Two persons” – connotes that a contract cannot be perfected if there is only one person, which is wrong. Auto-contracts
involve only one person, although such person represent different interests.
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AUTO-CONTRACTS: one person is responsible for the perfection of the contract but this person is acting in two capacities,
one in behalf of himself, one in behalf of another.
Generally valid: the number of parties is not determinative of the existence of a contract; what is important is that there be
at least 2 declaration of wills.
Example of a valid auto-contract: If the agent has been empowered to borrow money, he may himself be the lender at the
current rate of interest. (Art. 1890)
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LAW ON CONTRACTS
Examples of an auto-contract which is considered void:

1. Sale of property of a person under guardianship where the buyer is the guardian
2. Lease contract concerning the property belonging to an estate, where the lessee is the executor thereof.
ELEMENTS OF CONTRACTS
a. ESSENTIAL - those without which the contract cannot exist, i.e., Consent, object, consideration. In some contracts,
form and delivery is essential too.
b. NATURAL - those which exist as part of the contract even if the parties do not stipulate it because the law is deemed
written therein. Example: Warranty against eviction in a contract of sale or the warranty against hidden defects.
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c. ACCIDENTAL - those which are agreed upon by the parties and which cannot exist without being stipulated. Example:
stipulation for interest.
STAGES OF A CONTRACT
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a. NEGOTIATION (PREPARATION OR CONCEPTION OR GENERACION) – here the arties are progressing with their
negotiations; prior to the arrival on a definite agreement. Here is where the parties provide for their offers and bargain
with each other.
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b. PERFECTION (OR BIRTH) – when the parties have already came to a definite agreement and all the essential elements
are present (which includes form or delivey in some).
c. CONSUMMATION (OR DEATH OR TERMINATION) – the terms of the contract have already been performed.
CONSENT OF CONTRACTING PARTIES

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Consent: the meeting of the offer and the acceptance upon the thing and tthe cause which are to constitute the contract.
Offer and Acceptance:

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1. The offer must be certain
2. The acceptance must be absolute.
3. A qualified acceptance constitutes a counter-offer.
4. An acceptance may be express or implied.
5. The person making the offer may fix the time, place, and manner of acceptance, all of which must be complied with.
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COGNITION THEORY vs. MANIFESTATION THEORY:

1. Cognition Theory – follows that the acceptance takes effect from the time the offerer knew (or has knowledge) of the
acceptance of the offeree.
2. Manifestation Theory – on the other hand, follows that the acceptance will take effect once it is manifested by the
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offeree.
In the Philippines, we abide by the Cognition Theory, considering that Art. 1319 provides that: “Acceptance made by letter
or telegram does not bind the offerer except from the time it came to his knowledge. The contract, in such a case, is
presumed to have been entered into in the place where the offer was made.”
Intervening events: An offer becomes ineffective upon the death, civil interdiction, insanity, or insolvency of either party
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before acceptance is conveyed.
Option Agreement: When the offerer has allowed the offeree a certain period to accept, the offer may be withdrawn at any
time before acceptance by communicating such withdrawal, except when the option is founded upon a consideration, as
something paid or promised.
Advertisements: Unless it appears otherwise, business advertisements of things for sale are not definite offers, but mere
invitations to make an offer. Advertisements for bidders are simply invitations to make proposals, and the advertiser is not
bound to accept the highest or lowest bidder, unless the contrary appears.


LAW ON CONTRACTS
SITUATIONS CONCERNING CONSENT OF THE PARTIES:

a. Both parties gave consent their consent as to the essential elements of the contract – the contract is valid.
b. Simulation: which can either be:
i. Absolute simulation - when one or both the parties did not intend to be bound by the contract - the same is void.
ii. Relative simulation - if the parties merely conceal their true agreement relative simulation, they shall be bound by
their real agreement.
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c. Incapacity of one of the parties:
Kinds of Capacity:
(1) Juridical capacity - is the fitness to be the subject of legal relations which is inherent in every natural person and is
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lost only through death.
If incapacity pertains to juridical capacity the contract is void.
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(2) Capacity to act (or legal capacity) - is the power to do acts with legal effect which is acquired and may be lost.
If incapacity pertains to capacity to act or legal capacity, it can be:

i. Absolute Incapacity – the party cannot give consent in any contract, with anyone, in whatever capacity, over
anything.
The following cannot give consent to a contract:

a. Unemancipated minors;
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b. Insane or demented persons (except if consent is given during lucid interval);
c. Deaf-mutes who do not know how to write; and
d. Drunks or hypnotized.
Here the contract would be voidable as to the party who is incapacitated.

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Those who are “incompetent” under the Rules of Court who may be placed under guardianship:
a. Those suffering civil interdiction
b. Hospitalized lepers
c. Prodigals
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d. Deaf and dumb who are unable to read and write

e. Those of unsound mind even though they have lucid intervals
f. Those who by reason of age, disease, weak mind, and other similar causes, cannot without outside aid, take
care of themselves and manage their property, becoming thereby an ease prey for deceit and exploitation.
Note that these people (save for those suffering the penalty of civil interdiction) can still enter into contracts if not
placed under guardianship. However, it can still be proven that intelligent consent was not given and thus, may still
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render the contract voidable.
ii. Relative Incapacity – a person may be prohibited from entering specific contracts or that in a contract, he may
be prohibited in a certain capacity, i.e., prohibited to be the buyer, or to specific things, or to specific persons.
Examples:
• An alien is prohibited under the Constitution from acquiring private lands. EXCEPT: when acquired through
(1) succession; or (2) sale of residential land to a former natural born Filipino citizen.


LAW ON CONTRACTS
• Husbands and wives cannot enter into a contract of sale, unless they agreed to a Separation of Property
marital property regime or they have been legally separated.
d. Both are incapacitated: the contract is unenforceable.
e. Both parties gave their consent, but such consent was vitiated:
Vices of consent: would render the contract voidable. Like:

a. Mistake
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Mistake will make the contract voidable if:
i. It pertains to the object – e.g., gold-plated watch
ii. It pertains to the principal conditions – e.g., area of the land, when there is already a plan for the intended area
iii. Identity or qualifications of the parties – when they are principal causes – e.g., reviewers in a review school.
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iv. Legal effect that frustrates the agreement of the parties and the same is mutual – e.g., S delivered his car to B,
B gave money to S:
a. S thinks it is a contract of loan secured by a pledge;
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b. B thinks it is a pacto de retro sale
b. Violence - when in order to wrest consent, serious or irresistible force is employed.
c. Intimidation - when one of the contracting parties is compelled by a reasonable and well-grounded fear of an
ascendants, to give his consent.

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imminent and grave evil upon his person or property, or upon the person or property of his spouse, descendants or
To determine the degree of intimidation, the age, sex and condition of the person shall be borne in mind.
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A threat to enforce one's claim through competent authority, if the claim is just or legal, does not vitiate consent.
d. Undue Influence - when a person takes improper advantage of his power over the will of another, depriving the
latter of a reasonable freedom of choice.
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The following circumstances shall be considered: the confidential, family, spiritual and other relations between the
parties, or the fact that the person alleged to have been unduly influenced was suffering from mental weakness, or
was ignorant or in financial distress.
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e. Fraud - when, through insidious words or machinations of one of the contracting parties, the other is induced to
enter into a contract which, without them, he would not have agreed to:
There is NO FRAUD in the following cases:

1. Failure to disclose facts, when there is NO duty to reveal them.
2. The usual exaggerations in trade, when the other party had an opportunity to know the facts.
3. A mere expression of an opinion does not signify fraud, UNLESS made by an expert and the other party has
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relied on the former's special knowledge

4. Misrepresentation by a third person does not vitiate consent, unless such misrepresentation has created
substantial mistake and the same is mutual.
5. Misrepresentation made in good faith is not fraudulent but may constitute error
OTHER RULES:
1. In order that fraud may make a contract voidable, it should be serious and should not have been employed by
both contracting parties.
2. Incidental fraud only obliges the person employing it to pay damages.


LAW ON CONTRACTS
OBJECT CERTAIN WHICH IS THE SUBJECT MATTER
Object (Subject Matter) of the Contract: is really to create or to end obligations, which, in turn, may involve things, rights
or services.
Requisites:
1. The thing, right or service must be within the commerce of man;
2. It must be transmissible;
3. It must not be contrary to law, morals, good customs, public order or public policy;
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4. It must not be impossible;
5. It must be determinate as to its kind or determinable without the need of a new contract or agreement.
Future Inheritance: cannot be the subject matter of a valid contract. This is because the seller owns no inheritance while
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his predecessor lives. Public policy demands that if you’re going to sell, you have the right to do so, but not necessarily
requiring that the seller is the owner.
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CAUSE OR CONSIDERATION
Cause is the essential or impelling reason why a party assumes an obligation.

a. Onerous – for each contracting party, the prestation or promise of a thing or service by the other;
b. Gratuitous – mere liberality of the benefactor
c. Remuneratory – service or benefit already rendered.
Rules on Cause:
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a. Contracts without cause, or with unlawful cause, produce no effect whatever. The cause is unlawful if it is contrary to
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law, morals, good customs, public order or public policy
b. The statement of a false cause in contracts shall render them void, if it should not be proved that they were founded
upon another cause which is true and lawful.
c. Although the cause is not stated in the contract, it is presumed that it exists and is lawful, unless the debtor proves the
contrary.
d. As a rule, inadequacy of the price will not affect the contract. Except:
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(1) When expressly provided by law, e.g., rescissible contracts;

(2) When there has been fraud, mistake or undue influence.
e. The particular motives of the parties in entering into a contract are different from the cause thereof.
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OTHER ESSENTIAL ELEMENTS: in some cases, delivery is required for the perfection of the contract; in others, there are
formal requirements.
Real Contracts: are those which are perfected by delivery, thus, delivery is an essential element to its perfection. Real
contracts include:
1. Deposit
2. Pledge
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3. Commodatum
4. Loan or Mutuum
FORMS OF CONTRACT
GENERAL RULE: no form is required for the validity or perfection of a contract.
Formalities required for VALIDITY:

1. Donations of real property which requires a public instrument.


LAW ON CONTRACTS
2. Donations of personal property which exceeds P5,000 which requires that the donation be written.
3. Stipulation to pay interests on loans or for the use of money, which must be in writing.
4. Sale or transfer of large cattle which requires that it be in a public instrument, registered and that there should be a
certificate of transfer.
5. Contribution of real property in a partnership, which requires that there be an inventory attached to a public instrument.
Formalities required for ENFORCEABILITY (STATUTE OF FRAUDS): The following are unenforceable, unless they are
in writing, or some note or memorandum and subscribed by the party charged, or by his agent:
1. An agreement that by its terms is not to be performed within a year from the making thereof;
2. A special promise to answer for the debt, default, or miscarriage of another;
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3. An agreement made in consideration of marriage, other than a mutual promise to marry;
4. An agreement for the sale of goods, chattels or things in action, at a price not less than five hundred pesos, unless the
buyer accept and receive part of such goods and chattels, or the evidences, or some of them, of such things in action
or pay at the time some part of the purchase money; but when a sale is made by auction and entry is made by the
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auctioneer in his sales book, at the time of the sale, of the amount and kind of property sold, terms of sale, price, names
of the purchasers and person on whose account the sale is made, it is a sufficient memorandum;
5. An agreement of the leasing for a longer period than one year, or for the sale of real property or of an interest therein;
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6. A representation as to the credit of a third person.
Formalities required for CONVENIENCE: to bind third persons, the following are required to appear in a public instrument:
1. Acts and contracts which have for their object the creation, transmission, modification or extinguishment of real rights
over immovable property; sales of real property or of an interest therein a governed by the Statute of Frauds.
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2. The cession, repudiation or renunciation of hereditary rights or of those of the conjugal partnership of gains;
3. The power to administer property, or any other power which has for its object an act appearing or which should appear
in a public document, or should prejudice a third person;
4. The cession of actions or rights proceeding from an act appearing in a public document.
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Remedy to require a specific form: if the law requires a document or other special form if the contract is VALID and
ENFORCEABLE, as in the acts and contracts required to appear in a public instrument for convenience (where the
requirement that they must be in writing for validity, if applicable, is met), the contracting parties may compel each other to
observe that form, once the contract has been perfected. E.g., a contract of sale of land in a private instrument is valid and
enforceable, and the parties may compel that it appear in a public instrument.
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REFORMATION OF INSTRUMENTS
Reformation: is the remedy by means of which a written instrument is made or construed so as to express or conform to
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the true intention of the parties when some error or mistake has been committed.
Requisites:
a. There is a meeting of the minds;
b. There is a written instrument; and
c. The written instrument does not reflect the true intention of the parties.
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When may reformation be had:

1. Mutual mistake of the parties. If one party was mistaken and the other acted fraudulently or inequitably in such a way
that the instrument does not show their true intention, the former may ask for the reformation of the instrument
2. When one party was mistaken and the other knew or believed that the instrument did not state their real agreement,
but concealed that fact from the former.
3. Ignorance, lack of skill, negligence or bad faith on the part of the person drafting the instrument or of the clerk or typist.
4. If two parties agree upon the mortgage or pledge of real or personal property, but the instrument states that the property
is sold absolutely or with a right of repurchase.


LAW ON CONTRACTS
Who can ask for reformation:

1. If the mistake was mutual, reformation may be ordered at the instance of either party or his successor in interest;
2. Otherwise, the injured party, or his heirs and assigns.
No reformation is allowed:
a. Simple donations inter vivos wherein no condition is imposed;
b. Wills;
c. When the real agreement is void.
Likewise, when one of the parties has brought an action to enforce the instrument, he cannot subsequently ask for its
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reformation.
FUNDAMENTAL CHARACTERISTICS/PRINCIPLES OF CONTRACTS
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1. CONSENSUALITY OF CONTRACTS
Perfection of a contract: is generally by the meeting of the minds or consensual, save for some cases where delivery or
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form is required for its perfection.
Contract entered into by an unauthorized person: is unenforceable since the rule is that no one may contract in the
name of another without being authorized by the latter, such as an agent, or unless he has by law a right to represent him,
such as a guardian.
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The same is true if the person, while authorized or has legal representation, acted beyond his powers.
Unless, in both cases, the contract is ratified, expressly or impliedly, by the person on whose behalf it has been executed,
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before it is revoked by the other contracting party.
CONTRACT OF ADHESION - one where there is already a prepared form containing the stipulations desired by one party
whereby the latter only asks the other party to agree to them if he wants to enter into a contract.
Generally valid: because a party who does not consent to the terms and conditions in the contract can opt not to.
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2. AUTONOMY OF CONTRACTS (FREEDOM OR LIBERTY TO CONTRACT)
The contracting parties may establish such stipulations, clauses, terms and conditions as they may deem convenient,
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provided they are not contrary to law, morals, good customs, public order, or public policy.
Contrary to Law: note that the law is deemed part of every contract and must thus be not contrary to the same.
a. Waiver for future fraud.
b. Partnership: Pactum Leonina – a stipulation which excludes one or more partners from any share in the profits or losses
c. Mortgage/Pledge: Pactum Commissorium – a stipulation where the creditor appropriates the things given by way of
pledge or mortgage, or dispose of them.
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d. Real Estate Mortgage: Pactum de non aliendo – a stipulation forbidding the owner from alienating the immovable
mortgaged.
Contrary to Public Policy:

a. Refund of tuition fees during the time a student is covered by a scholarship if such student transfers schools.
Scholarships are granted not to attract and to keep brilliant students in school for their propaganda mine but to reward
merit or help gifted students in whom society has an established interest or a first lien. (Cui vs. Arellano)
b. Prohibiting a losing candidate in a convention to run as an independent candidate is contrary to constitutionality
protected right to be elected in public office and the right of the electorate to choose. (Saura vs. Sindico)


LAW ON CONTRACTS
Contrary to Morals: in a contract of loan, where the interest rate is 50%, maybe declared void or reduced for being contrary
to morals, the same being unconscionable, confiscatory, exorbitant, excessive or inequitable, not because of it is usurious.
3. MUTUALITY
The contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them. This
principle stresses that both parties are bound. The principle is based on the essential equality of the parties since it would
be unfair if it is binding on one party and yet leave the other free.
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Consequences of Mutuality:
1. One party cannot revoke or renounce a contract without the consent of the other, nor have it said aside on the ground
that he had made a bad bargain.
2. The determination of the performance may be left to a third person:
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a. Whose decision shall not be binding until it has been made known both contracting parties
b. The determination shall not be obligatory if it is evidently inequitable. In such case, the courts shall decide what is
equitable under the circumstances.
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ESCALATION CLAUSE: where one increases/decreases compensation of one of the parties.
When Void: when the increase is dependent solely upon the will of one of the parties.
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The unilateral determination and imposition of increased interest rates by the bank is obviously violative of the principle of
mutuality of contracts ordained in Article 1308 of the Civil Code. (Sps. Florendo vs. CA)
When Valid: when the increase/decrease is dependent on valid and reasonable standards.
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Contract for a piece of work: where the compensation of the contractor may be increased on the basis of minimum wage
or as to materials, based on the consumer price index.
Contract of Lease: where the rental would be increased or decreased based on the movement (increase or devaluation)
of foreign exchange – valid. (Del Rosario vs. Shell)
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4. OBLIGATORY FORCE OF CONTRACTS
Obligations arising from contracts have the force of law between the contracting parties and should be complied with in
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good faith. (Art. 1159)
5. RELATIVITY OF CONTRACTS
RELATIVITY (OR PRIVITY) OF CONTRACTS: means that the contract takes effect only between the parties, their assigns
and heirs which are referred to as privies.
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Third Parties: as a general rule do not have a cause of action to enforce or annul a contract nor are they bound by the
terms thereof.
Exceptions:
a. Third person may be bound by the contract:
i. In contracts creating real rights, third persons who come into possession of the object of the contract are bound
thereby, subject to the provisions of the Mortgage Law and the Land Registration Laws
ii. Collective contracts – such as a Collective Bargaining Agreement


LAW ON CONTRACTS
iii. Contracts that create a status – such as a marriage contract.
b. A creditor may initiate an action against the contracting parties
Creditors are protected in cases of contracts intended to defraud them. The following actions are allowed for creditors,
effectively interfering in contracts to which they are not parties to:
Accion Pauliana: is the action of the creditor to rescind the contract entered into by the debtor to defraud him.
Accion Directa: is the action of a creditor to sue on a contract entered into by his debtor, whenever authorized by law,
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such as:
(1) Those who put labor upon or furnish materials for a piece of work undertaken by the contractor have an action
against the owner up to the amount owing from the latter to the contractor at the time the claim is made.
(2) The sublessee is subsidiarily liable to the lessor for any rent due from the lessee. However, the sublessee shall not
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be responsible beyond the amount of rent due him, in accordance with the terms of the sublease, at the time of the
extrajudicial demand by the lessor.
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c. Third persons may be liable under a contract
Malicious interference by third persons: A third person who induces another to violate his contract shall be liable for
damages to the other contracting party. As the name implies, there should be malice or a malicious inducement by the
third person as a result of which, the debtor does not comply with his obligation under the contract, which necessarily
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implies that such third person has knowledge of the existence of the contract. (Art. 1314)
d. Third persons may be benefited by a contract – 2nd paragraph of Art. 1311, otherwise known as a stipulation
pour atrui.
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If a contract should contain some stipulation in favor of a third person, he may demand its fulfillment provided he
communicated his acceptance to the obligor before its revocation. A mere incidental benefit or interest of a person is
not sufficient. The contracting parties must have clearly and deliberately conferred a favor upon a third person.
Stipulation pour atrui: is a stipulation in favor of a third person conferring a clear and deliberate favor upon him, and
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which stipulation is merely part of a contract entered into by the parties, neither of whom acted as agent of the third
person.
Communication of acceptance to the obligor is required. No form is required. It can even be implied from the acts of the
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third person.
Revocation: cannot be done by one party alone. The Supreme Court has held that if this revocation is a unilateral act
of one of the parties, it is void for violation of the principle of mutuality of contracts. For a revocation to take effect, it
must be with consent of both parties (obligor and oblige) and should be done before the communication of acceptance
to the obligor.
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CLASSIFICATION OF CONTRACTS
1. ACCORDING TO DEGREE OF DEPENDENCE

a. PRINCIPAL – a contract which can stand on its own, such as a contract of sale, barter, lease, loan.
b. ACCESSORY – those which cannot stand on its own and are dependent upon other contracts for its validity. E.g.,
guaranty, suretyship, mortgage and antichresis.
c. PREPARATORY – a contract is a means to achieving an end, such as an option contract, a contract of partnership
and that of agency.


LAW ON CONTRACTS
2. ACCORDING TO PERFECTION
a. CONSENSUAL – are those perfected by mere consent.
b. REAL – those which are perfected only upon delivery of the thing subject of the contract. E.g., deposit, pledge,
commodatum and mutuum.
c. FORMAL – those which require a certain form for its validity. E.g., antichresis
3. ACCORDING TO PARTIES OBLIGED

a. BILATERAL – where both parties are reciprocally obligated, e.g., lease (where the lessor is obliged to allow the use
of the thing and the lessee is obliged to pay rent) and sale (where the buyer is obliged to pay the price and the seller
obliged to deliver the thing) (ARTS. 1642, 1458)
b. UNILATERAL – only one party is obliged. E.g., guaranty and pledge. (ARTS. 2047, 2093)
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Importance of Classification:
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As to FRUITS: in conditional obligations, who would be entitled to the fruits before the happening of the suspensive
condition?
a. Bilateral: the fruits are deemed mutually compensated under Art. 1187.
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b. Unilateral: the fruits shall pertain to the debtor unless a contrary intention is clear.
Rescission: under Art. 1191, is implied in reciprocal obligations, or in this case, bilateral contracts where both are
reciprocally obligated. But if the contract is unilateral, logically, the creditor would not rescind, he would either demand
performance or seek damages.
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Delay: in reciprocal obligations (bilateral contracts), from the moment one of the parties had already complied and the
other did not, the latter shall be considered in delay even if there is no demand.
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4. ACCORDING TO CAUSE
a. ONEROUS – such as a contract of sale, barter, lease and simple loans or mutuum with stipulation for interest.
b. GRATUITOUS OR LUCRATIVE – such as a donation and commodatum.
c. REMUNERATORY – where one prestation is given for a benefit or service that had been rendered previously.
Importance of Classification: would be on the application of presumptions that the transfer of ownership is in fraud of
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creditors and as to interpretation of contracts:
5. ACCORDING TO RISK
a. COMMUTATIVE – where the parties contemplate real fulfillment, therefore, equivalent values (presumably) are
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given, such as sales (where the price is presumably the equivalent of the thing to be delivered) or lease (where the
rental payments is presumably the value of the use of the thing)
b. ALEATORY – where the fulfillment of the cause as to one party is dependent upon chance, such as an insurance
contract (where the payment will depend on the happening of the event insured against)
6. ACCORDING TO NAME
a. NOMINATE – those contracts for which a particular name has been designated and rules particular to them are
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applicable such as sales, commodatum, partnership, agency, deposit, etc.

b. INNOMINATE – those which do not have particular designation, such as do ut des, do ut facias, facio ut des and
facio ut facias.
INTERPRETATION OF CONTRACTS
Art. 1370. If the terms of a contract are clear and leave no doubt upon the intention of the contracting parties, the literal
meaning of its stipulations shall control.


LAW ON CONTRACTS
If the words appear to be contrary to the evident intention of the parties, the latter shall prevail over the former. (1281)
Primary Consideration: is the intention of the parties. Such that even if the terms of the contract are clear, but does not
reflect the intention of the parties, it is the intention which would prevail.
Art. 1371. In order to judge the intention of the contracting parties, their contemporaneous and subsequent acts shall be
principally considered. (1282)
Contemporaneous and Subsequent Acts: may be considered to determine if the parties’ intention are different from the
clear words of the agreement.
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In a case where a Deed of Assignment was issued as payment for the obligation of the debtor in an indemnity agreement
by way of dacion en pago, the debtor thereafter made subsequent installment payments and executed a mortgage, the SC
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held that clearly the subsequent acts of the debtor does not reflect his claim that the deed of assignment was by dacion en
pago. The deed of assignment was a form of security for the indemnity agreement.
Specific rules in interpretation of contracts:
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1. However general the terms of a contract may be, they shall not be understood to comprehend things that are distinct
and cases that are different from those upon which the parties intended to agree.
2. If some stipulation of any contract should admit of several meanings, it shall be understood as bearing that import which
is most adequate to render it effectual.
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3. The various stipulations of a contract shall be interpreted together, attributing to the doubtful ones that sense which may
result from all of them taken jointly.
4. Words which may have different significations shall be understood in that which is most in keeping with the nature and
object of the contract.
5. The usage or custom of the place shall be borne in mind in the interpretation of the ambiguities of a contract, and shall
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fill the omission of stipulations which are ordinarily established.
6. The interpretation of obscure words or stipulations in a contract shall not favor the party who caused the obscurity
When none of the above rules will apply:
When it is absolutely impossible to settle doubts by the rules established in the preceding articles, and the doubts refer to
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incidental circumstances of:

1. a gratuitous contract - the least transmission of rights and interests shall prevail.
2. If the contract is onerous, the doubt shall be settled in favor of the greatest reciprocity of interests.
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If the doubts are cast upon the principal object of the contract in such a way that it cannot be known what may have been
the intention or will of the parties, the contract shall be null and void. (Art. 1378)
DEFECTIVE CONTRACTS
1. RESCISSIBLE CONTRACTS
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Art. 1381. The following contracts are rescissible:

(1) Those which are entered into by guardians whenever the wards whom they represent suffer lesion by more than one-
fourth of the value of the things which are the object thereof;
(2) Those agreed upon in representation of absentees, if the latter suffer the lesion stated in the preceding number;
(3) Those undertaken in fraud of creditors when the latter cannot in any other manner collect the claims due them;
(4) Those which refer to things under litigation if they have been entered into by the defendant without the knowledge
and approval of the litigants or of competent judicial authority;
(5) All other contracts specially declared by law to be subject to rescission. (1291a)


LAW ON CONTRACTS
Lesion – is the damage or injury to the party asking for rescission, which represents the difference between the price and
the actual value of the property. Lesion, as a ground for rescission must be MORE THAN ONE-FOURHT of the value.
In fraud of creditors: where the remedy of the creditor is properly called “accion pauliana,” through which the creditor can
interfere and have the contract entered into by the debtor rescinded.
This presupposes that the creditor cannot in any other manner collect the claims due. Thus, if the debtor entered into a
contract of sale with a third person in order to have enough money to pay the creditor, the latter cannot rescind such contract
of sale since the sale was precisely entered into to pay him his due.
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Presumption of Fraud:
a. Alienations by gratuitous title: presumed to have been entered into in fraud of creditors, when the donor did not
reserve sufficient property to pay all debts contracted before the donation.
b. Alienations by onerous title: presumed fraudulent when made by persons against whom some judgment has been
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issued. The decision or attachment need not refer to the property alienated, and need not have been obtained by the
party seeking the rescission.
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Things under litigation: a contract having a thing under litigation as its subject matter is rescissible whenever entered into
without the knowledge and approval of:
a. The litigants; or
b. Competent judicial authority (such as the court under which the thing is subject to litigation).
Other contract subject to rescission under the law:

a. Rights of an unpaid seller;
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b. In obligations to deliver a specific thing, where the same deteriorates with the fault of the debtor before the suspensive
condition is fulfilled (or suspensive term arrives);
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c. Lesion of at least one-fourth in partition.
d. In sale of real estate for a certain price per unit of measure and the real estate delivered is deficient by more than 1/10
or when the buyer would not have entered into the contract knowing the actual area of the real estate.
e. Payments made in a state of insolvency for obligations whose fulfillment the debtor could not be compelled at the time
they were effected.
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Rescission: is a process designated to render inefficacious a contract validly entered into and normally binding, by reason
of external conditions, causing an economic prejudice to a party or his creditors.
Resolution: is the proper term for “rescission” which is a remedy under Art. 1911 in reciprocal obligations. Unlike the proper
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rescission for rescissible contracts, resolution is a primary remedy which can be availed of by the parties and does not
require lesion as a ground therefor but will require non-performance or non-fulfillment of the obligation or when there is
substantial breach.
Rescission as a remedy:
a. The action for rescission is subsidiary; it cannot be instituted except when the party suffering damage has no other legal
means to obtain reparation for the same
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b. Rescission shall be only to the extent necessary to cover the damages caused
c. Restitution - rescission creates the obligation to return the things which were the object of the contract, together with
their fruits, and the price with its interest.
d. It can be carried out only when he who demands rescission can return whatever he may be obliged to restore
e. Rescission shall not take place when the things which are the object of the contract are legally in the possession of third
persons who did not act in bad faith. In which case, indemnity for damages may be demanded from the person causing
the loss.
f. If the sale of the property of the guardian or the absentee is approved by courts, rescission is not an available remedy.


LAW ON CONTRACTS
Prescriptive Period: the action to claim rescission must be commenced within 4 years. For persons under guardianship
and for absentees, such four year period shall begin upon termination of the ward’s incapacity or when the absentee’s
domicile is known.
Sale of land, 4 years is counted from the time of registration: When a transaction involves registered land, the four-year
period fixed in Article 1391 within winch to bring an action for annulment of the deed, shall be computed from the registration
of the conveyance.
The registration of the document is constructive notice of the conveyance to the whole world. (HSBC vs. Pauli)
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2. VOIDABLE CONTRACTS
Voidable Contracts: are those which are valid until they have been annulled by proper action in court. However, they are
likewise subject to ratification to cure the defect.
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The following are voidable contracts:
a. Those where one of the parties is incapable of giving consent;
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b. Those where the consent is vitiated by mistake, violence, intimidation, undue influence or fraud.
Prescriptive Period: to annul a voidable contract shall be four years.
Ground Counted from:
Mistake or fraud
Minority or incapacity
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Intimidation, violence or undue influence The defect of the consent ceases
Discovery
Guardianship ceases
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Ratification: extinguishes the action to annul a voidable contract.
a. Ratification may be effected by the guardian of the incapacitated person
b. It does not require the conformity of the contract party who has no right to bring the action for annulment.
c. It cleanses the contract from all the defects from the moment it was constituted.
d. It may be done:
i. Expressly – either oral or written; or
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ii. Tacitly (impliedly) – when the reason which renders the contract voidable has ceased, the person who has a right
to invoke annulment should execute an act which necessarily implies an intention to waive such right.
Annulment: renders the contract non-existing, as if it was never entered into.

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a. Only the injured party (the victim, whether principal or subsidiary party) may ask for annulment.
b. Creditors of the injured party cannot ask for the annulment of the contract for they are not parties thereto.
c. In case of minority, and the minor misrepresents his age and the other party was led to believe the same, there can be
no annulment, for here, the minor would be estopped.
d. Those who are capacitated cannot allege the incapacity of those with whom they contracted with nor those who exerted
intimidation, violence or undue influence, or employed fraud, or caused mistake.
e. Effects of loss of the thing:
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i. The action for annulment of contracts shall be extinguished when the thing which is the object thereof is lost through
the fraud or fault of the person who has a right to institute the proceedings.
ii. If the right of action is based upon incapacity, the loss of the thing shall not be an obstacle to the success of the
action, unless said loss took place through the fraud or fault of the incapacitated person.
f. Effects of annulment:
i. Generally, the parties are obliged to restore to each other the things which have been the subject matter of the
contract, with their fruits and the price with its interest.
ii. In obligations to render service, the value thereof shall be the basis for damages.


LAW ON CONTRACTS
iii. In case of incapacity, the person incapacitated is not obligated to make any restitution except insofar as he has
been benefited by the thing or price received by him.
iv. Whenever the person who is obliged to return the thing cannot do so because it has been lost through his fault, he
shall return:
1) the fruits received and
2) the value of the thing at the time of loss
3) with interest from the same date.
v. When one party does not return what is due him by virtue of the annulment, he cannot compel the other to comply
what is incumbent upon him.
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3. UNENFORCEABLE CONTRACTS
Unenforceable contracts – are those which have no effect until they are ratified.
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Kinds of Unenforceable Contracts:
a. Unauthorized contracts – those entered into in the name of a person by one who has been given no authority or legal
representation, or who has acted beyond his powers.
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b. Those that do not comply with the Statute of Frauds – these are agreements that are required to be in writing in
order to avoid fraud.
Statute of Frauds: in order to be enforceable, the following must be in writing, or in some note or memorandum:
i. An agreement that by its terms is not to be performed within a year from the making thereof.
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ii. A special promise to answer for the debt, default, or miscarriage of another;
iii. An agreement made in consideration of marriage, other than a mutual promise to marry;
iv. An agreement for the sale of goods, chattels or things in action, at a price not less than five hundred pesos, unless
the buyer accept and receive part of such goods and chattels, or the evidences, or some of them, of such things in
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action or pay at the time some part of the purchase money; but when a sale is made by auction and entry is made
by the auctioneer in his sales book, at the time of the sale, of the amount and kind of property sold, terms of sale,
price, names of the purchasers and person on whose account the sale is made, it is a sufficient memorandum;
* This refers only to a contract of sale where the price of the thing is P500 or more.
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v. An agreement of the leasing for a longer period than one year, or for the sale of real property or of an interest
therein.
*The requirement here is that the contract must be in writing. However, in case of sale of LAND made through an
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AGENT, the authority of the agent must be writing, otherwise, the sale is void.
vi. A representation as to the credit of a third person.
Rules Applicable to Statute of Frauds:

i. It applies only to executory contracts, and not those which have been partially or completely executed.
ii. The list is exclusive, that is, it applies only to the agreements or contracts enumerated above.
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iii. The defense of Statute of Frauds may be waived.

iv. The Statute of Frauds is a personal defense, that is, an agreement infringing it cannot be assailed by third persons.
v. If oral evidence is presented to prove the agreement, and the other does not object thereto, there is deemed a
waiver of the defense of Statute of Frauds. The same is true if the other party has already accepted the benefits of
the contract.
c. Those where both parties are incapable of giving consent.
4. VOID OR INEXISTENT


LAW ON CONTRACTS
Void Contracts are those which are either inexistent (as when the required formalities are not complied with for its
perfection, which produces no legal effects), or illegal or illicit.
Art. 1409. The following contracts are inexistent and void from the beginning:
(1) Those whose cause, object or purpose is contrary to law, morals, good customs, public order or public policy;
(2) Those which are absolutely simulated or fictitious;
(3) Those whose cause or object did not exist at the time of the transaction;
(4) Those whose object is outside the commerce of men;
(5) Those which contemplate an impossible service;
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(6) Those where the intention of the parties relative to the principal object of the contract cannot be ascertained;
(7) Those expressly prohibited or declared void by law.
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These contracts cannot be ratified. Neither can the right to set up the defense of illegality be waived.
Rules Applicable:
a. The action or defense for the declaration of the contract as inexistent does not prescribe.
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b. The contract cannot be ratified.
c. It cannot give rise to valid subsequent contracts if the same are based on it.
d. Generally, produces no effect and no action to declare them void is needed.
e. When money is paid or property delivered for an illegal purpose, the contract may be repudiated by one of the parties
before the purpose has been accomplished, or before any damage has been caused to a third person. In such case,
or property.
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the courts may, if the public interest will thus be subserved, allow the party repudiating the contract to recover the money
f. Where one of the parties to an illegal contract is incapable of giving consent, the courts may, if the interest of justice so
demands allow recovery of money or property delivered by the incapacitated person.
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g. When the agreement is not illegal per se but is merely prohibited, and the prohibition by the law is designated for the
protection of the plaintiff, he may, if public policy is thereby enhanced, recover what he has paid or delivered.
h. In case of a divisible contract, if the illegal terms can be separated from the legal ones, the latter may be enforced.
i. The defense of illegality of contract is not available to third persons whose interests are not directly affected
Illegal Contracts: can either be that which involves a criminal offense or where there is no criminal offense.
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a. When there is a criminal offense, it may be of two kinds:

i. Those where both parties are guilty (in pari delicto) – they shall have no action against each other; they shall both
be prosecuted; the effects of the crime shall be confiscated in favor of the government. Example is when both
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parties entered into a contract to smuggle contraband.

ii. Those where only one is guilty and the other is innocent:
1) The guilty party will be prosecuted;
2) The instrument of the crime (or object of the contract) will be confiscated;
3) The innocent one may claim what he has given.
b. When there is no criminal offense, which may be:
i. Where both are guilty – where neither can recover what he has given by virtue of the contract or demand the
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performance of the other’s undertaking.

ii. Where only one is guilty or at fault – where the guilty party cannot recover what he has given by reason of the
contract or ask for the fulfillment of what had been promised him and the party not at fault may demand the return
of what he has given, without any obligation to comply with his promise.
--- END OF HANDOUTS ---


Law Contracts Guide CPA Review

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Page 1 of 15 | RFBT 02

Criticisms in the definition provided under Art. 1305:

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

ATTY. NICKO SORIANO, CPA

Examples of an auto-contract which is considered void:

CONSENT OF CONTRACTING PARTIES

Offer and Acceptance:

COGNITION THEORY vs. MANIFESTATION THEORY:

before acceptance is conveyed.

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

ATTY. NICKO SORIANO, CPA

SITUATIONS CONCERNING CONSENT OF THE PARTIES:

b. Simulation: which can either be:

If incapacity pertains to juridical capacity the contract is void.

If incapacity pertains to capacity to act or legal capacity, it can be:

The following cannot give consent to a contract:

Here the contract would be voidable as to the party who is incapacitated.

d. Deaf and dumb who are unable to read and write

render the contract voidable.

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

ATTY. NICKO SORIANO, CPA

d. Both are incapacitated: the contract is unenforceable.

Vices of consent: would render the contract voidable. Like:

b. Violence - when in order to wrest consent, serious or irresistible force is employed.

ascendants, to give his consent.

There is NO FRAUD in the following cases:

relied on the former's special knowledge

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

ATTY. NICKO SORIANO, CPA

OBJECT CERTAIN WHICH IS THE SUBJECT MATTER

Cause is the essential or impelling reason why a party assumes an obligation.

(1) When expressly provided by law, e.g., rescissible contracts;

GENERAL RULE: no form is required for the validity or perfection of a contract.

Formalities required for VALIDITY:

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

ATTY. NICKO SORIANO, CPA

When may reformation be had:

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

ATTY. NICKO SORIANO, CPA

Who can ask for reformation:

FUNDAMENTAL CHARACTERISTICS/PRINCIPLES OF CONTRACTS

2. AUTONOMY OF CONTRACTS (FREEDOM OR LIBERTY TO CONTRACT)

Contrary to Public Policy:

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

ATTY. NICKO SORIANO, CPA

4. OBLIGATORY FORCE OF CONTRACTS

good faith. (Art. 1159)

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

ATTY. NICKO SORIANO, CPA

iii. Contracts that create a status – such as a marriage contract.

b. A creditor may initiate an action against the contracting parties

1. ACCORDING TO DEGREE OF DEPENDENCE

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

ATTY. NICKO SORIANO, CPA

3. ACCORDING TO PARTIES OBLIGED

creditors and as to interpretation of contracts:

applicable such as sales, commodatum, partnership, agency, deposit, etc.

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

ATTY. NICKO SORIANO, CPA

Specific rules in interpretation of contracts:

When none of the above rules will apply:

incidental circumstances of: