Article 1226: Contracts with Penal Clause

In obligation with a penal clause, the penalty shall substitute the indemnity for damages
and the payment of interest in case of noncompliance, if there is no stipulation to the
contrary. Nevertheless, damages shall be paid if the obligor refuses to pay the penalty
or is guilty of fraud in the fulfillment of the obligation.

The penalty may be enforced only when it is demandable in accordance with the
provisions of this code.

Penal Clause:

A penal clause is an accessory undertaking attached to an obligation to assume greater

liability on the part of the obligor in case of breach of obligation.

Purposes of Penal Clause:

1. Ensure performance- to ensure the performance or compliance of obligation.

2. Substitute the indemnity for damages and the payment of interest in case of
noncompliance- instead of computing the actual damage of because of
noncompliance. Also the obligor is bound to pay stipulated indemnity and need
not to provide existence measure of damages because of breach of contract.

3. Punish the debtor for the non-fulfillment of his obligation- third purpose serves as
punishment because the obligor failed to comply in the obligation.

Example:

A promised to construct the house of B within 90 days for One Million Pesos.

“For every day’s delay after the stipulated 90 days, A would pay a fine/penalty of Php
10,000 to B.”

This explains that if A is not able to finish the construction of B’s house within 90 days,
he will pay a penalty each exceeding day in their stipulation. For example, the house
was finished after 95 days, B instead of paying Php 1,000,000, she will only pay
Php950,000 because of the penalty. 5 days X Php10,000 is equal to Php50,000.

Kinds of Penal Clause:

1. As to its origin:
Legal Penal Clause- this is provided by the law.
Conventional Penal Clause- constituted by the agreement of the both
parties.
2. As to its purpose:
Compensatory Penal Clause- penalty takes a place of damages.
Punitive Penal Clause- penalty is imposed merely as punishment for
breach.
3. As to its dependability or effect:
Subsidiary or Alternative Penal Clause- only one alternative or subsidiary,
it’s either the principal obligation or the penalty.
Joint or Cumulative Penal Clause- both principal and penal clause can be
claimed.

Going back to Article 1226, the penalty is going to be the substitute for the interest or
the indemnity for damages and the payment of interest but still there are 3 different
scenarios in this article;

In obligation with a penal clause, the penalty shall substitute the indemnity for damages
and the payment of interest in case of noncompliance, (1st) if there is no stipulation to
the contrary. Nevertheless, (2nd) damages shall be paid if the obligor refuses to
pay the penalty or (3rd) is guilty of fraud in the fulfillment of the obligation.

The penalty may be enforced only when it is demandable in accordance with the
provisions of this code.

1 if there is no stipulation to the contrary –

2 damages shall be paid if the obligor refuses to pay the penalty - the creditor will
be able to receive interest because of the damages done by not paying the penalty, this
is also where legal interest will start.

3 is guilty of fraud in the fulfillment of the obligation. – if the debtor is guilty of fraud,
he is also liable for damages in conformity in Article 1171 and also there is a need of
proof of fraud.

And the last sentence:

1 The penalty may be enforced only when it is demandable in accordance with the
provisions of this code – this phrase means that the penalty stipulation in the contract
is demandable only if there is a breach of the obligation and also provided that the penal
clause is not a contrary in the law or it does not contradict the law, good morals,
customs, public order, and policy.